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 March 31, 2010

 

 

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)

 

Delaware

 

20-8370041

(State or Other Jurisdiction of Incorporation or Organization)

 

(IRS Employer Identification Number)

 

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 o  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):

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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 April 12, 2010, there were 58,016,267 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 March 31, 2010

 

Table of Contents

 

 

 

Page No.

PART I.

Financial Information

3

 

 

 

Item 1.

Condensed Consolidated Financial Statements (unaudited):

3

 

Condensed Consolidated Balance Sheets

3

 

Condensed Consolidated Statements of Operations

4

 

Condensed Consolidated Statements of Cash Flows

5

 

Notes to Condensed Consolidated Financial Statements

6

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

19

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

28

 

 

 

Item 4.

Controls and Procedures

28

 

 

 

PART II.

Other Information

29

 

 

 

Item 1.

Legal Proceedings

29

 

 

 

Item 1A.

Risk Factors

29

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

49

 

 

 

Item 3.

Defaults Upon Senior Securities

49

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

49

 

 

 

Item 5.

Other Information

49

 

 

 

Item 6.

Exhibits

50

 

 

 

Signatures

 

51

 

2



Table of Contents

 

PART I.                FINANCIAL INFORMATION

 

Item 1.   Condensed Consolidated Financial Statements

 

Accuray Incorporated

Condensed Consolidated Balance Sheets

(in thousands, except share and per share amounts)

 

 

 

March 31,

 

June 30,

 

 

 

2010

 

2009

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

36,036

 

$

36,835

 

Restricted cash

 

21

 

527

 

Short-term available-for-sale securities

 

81,542

 

64,634

 

Trading securities

 

21,860

 

 

Accounts receivable, net of allowance for doubtful accounts of $35 and $484 at March 31, 2010 and June 30, 2009, respectively

 

36,321

 

36,427

 

Inventories

 

28,231

 

28,909

 

Prepaid expenses and other current assets

 

11,636

 

6,186

 

Deferred cost of revenue—current

 

12,876

 

18,984

 

Total current assets

 

228,523

 

192,502

 

Long-term available-for-sale securities

 

6,359

 

35,245

 

Long-term trading securities

 

 

22,007

 

Deferred cost of revenue—noncurrent

 

3,274

 

2,933

 

Property and equipment, net

 

13,242

 

15,066

 

Goodwill

 

4,495

 

4,495

 

Intangible assets, net

 

452

 

668

 

Other assets

 

1,630

 

1,470

 

Total assets

 

$

257,975

 

$

274,386

 

Liabilities and stockholders’ equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

9,734

 

$

14,941

 

Accrued compensation

 

9,618

 

10,119

 

Other accrued liabilities

 

7,404

 

5,649

 

Customer advances

 

13,170

 

13,185

 

Deferred revenue—current

 

50,830

 

68,105

 

Total current liabilities

 

90,756

 

111,999

 

Long-term liabilities:

 

 

 

 

 

Long-term other liabilities

 

928

 

708

 

Deferred revenue—noncurrent

 

4,599

 

7,777

 

Total liabilities

 

96,283

 

120,484

 

Commitments and contingencies (Note 6)

 

 

 

 

 

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: 100,000,000 shares; issued: 60,147,061 and 58,783,547 shares at March 31, 2010 and June 30, 2009, respectively; outstanding: 58,007,043 and 56,643,529 shares at March 31, 2010 and June 30, 2009, respectively

 

58

 

57

 

Additional paid-in capital

 

284,268

 

273,946

 

Accumulated other comprehensive income

 

62

 

416

 

Accumulated deficit

 

(122,696

)

(120,517

)

Total stockholders’ equity

 

161,692

 

153,902

 

Total liabilities and stockholders’ equity

 

$

257,975

 

$

274,386

 

 

Condensed consolidated balance sheet at June 30, 2009 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

(in thousands, except per share amounts)

(unaudited)

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

March 31,

 

March 31,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

 

 

 

 

 

 

 

 

Net revenue:

 

 

 

 

 

 

 

 

 

Products

 

$

33,783

 

$

41,006

 

$

99,815

 

$

119,762

 

Shared ownership programs

 

484

 

1,285

 

1,421

 

3,197

 

Services

 

17,545

 

17,901

 

57,887

 

47,730

 

Other

 

128

 

1,109

 

714

 

4,106

 

Total net revenue

 

51,940

 

61,301

 

159,837

 

174,795

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

Cost of products

 

14,430

 

17,630

 

46,638

 

49,894

 

Cost of shared ownership programs

 

228

 

185

 

877

 

654

 

Cost of services

 

11,806

 

12,057

 

38,859

 

32,214

 

Cost of other

 

100

 

1,067

 

503

 

3,833

 

Total cost of revenue

 

26,564

 

30,939

 

86,877

 

86,595

 

Gross profit

 

25,376

 

30,362

 

72,960

 

88,200

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Selling and marketing

 

7,179

 

11,420

 

25,891

 

35,623

 

Research and development

 

7,719

 

9,259

 

23,150

 

26,807

 

General and administrative

 

7,719

 

8,821

 

27,079

 

28,513

 

Total operating expenses

 

22,617

 

29,500

 

76,120

 

90,943

 

Income (loss) from operations

 

2,759

 

862

 

(3,160

)

(2,743

)

Other income (loss), net

 

(227

)

575

 

684

 

2,436

 

Income (loss) before provision for (benefit from) income taxes

 

2,532

 

1,437

 

(2,476

)

(307

)

Provision for (benefit from) income taxes

 

260

 

221

 

(297

)

306

 

Net income (loss)

 

$

2,272

 

$

1,216

 

$

(2,179

)

$

(613

)

Net income (loss) per share:

 

 

 

 

 

 

 

 

 

Basic net income (loss) per share

 

$

0.04

 

$

0.02

 

$

(0.04

)

$

(0.01

)

Weighted average common shares used in computing basic net income (loss) per share

 

57,851

 

55,724

 

57,352

 

55,138

 

Diluted net income (loss) per share

 

$

0.04

 

$

0.02

 

$

(0.04

)

$

(0.01

)

Weighted average common shares used in computing diluted net income (loss) per share

 

60,470

 

58,772

 

57,352

 

55,138

 

 

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)

 

 

 

Nine Months Ended March 31,

 

 

 

2010

 

2009

 

 

 

 

 

 

 

Cash Flows From Operating Activities

 

 

 

 

 

Net loss

 

$

(2,179

)

$

(613

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

Depreciation and amortization

 

5,564

 

4,983

 

Stock-based compensation

 

8,237

 

11,676

 

Excess tax benefit from stock-based compensation

 

 

(356

)

Realized gain on investments

 

(2

)

(18

)

Unrealized loss on long-term trading securities, net of gain on put option

 

(251

)

740

 

Provision for bad debts

 

(460

)

450

 

Provision for write-down of inventories

 

271

 

2,638

 

Loss on disposal of property and equipment

 

27

 

203

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

727

 

592

 

Inventories

 

586

 

(9,234

)

Prepaid expenses and other current assets

 

(5,484

)

1,653

 

Deferred cost of revenue

 

5,176

 

17,088

 

Other assets

 

(162

)

24

 

Accounts payable

 

(5,494

)

(1,757

)

Accrued liabilities

 

1,521

 

4,260

 

Customer advances

 

44

 

(12,253

)

Deferred revenue

 

(20,990

)

(30,003

)

Net cash used in operating activities

 

(12,869

)

(9,927

)

Cash Flows From Investing Activities

 

 

 

 

 

Purchases of property and equipment

 

(2,529

)

(2,258

)

Restricted cash

 

439

 

3,737

 

Purchase of investments

 

(74,302

)

(116,061

)

Sale and maturity of investments

 

86,347

 

116,881

 

Net cash provided by investing activities

 

9,955

 

2,299

 

Cash Flows From Financing Activities

 

 

 

 

 

Proceeds from issuance of common stock

 

1,499

 

3,168

 

Proceeds from employee stock purchase plan

 

872

 

806

 

Excess tax benefit from stock-based compensation

 

(498

)

356

 

Net cash provided by financing activities

 

1,873

 

4,330

 

Effect of exchange rate changes on cash

 

242

 

269

 

Net decrease in cash and cash equivalents

 

(799

)

(3,029

)

Cash and cash equivalents at beginning of period

 

36,835

 

36,936

 

Cash and cash equivalents at end of period

 

$

36,036

 

$

33,907

 

 

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

 

5


 


Table of Contents

 

Accuray Incorporated

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

1. DESCRIPTION OF BUSINESS

 

Organization

 

Accuray Incorporated (the “Company”) designs, develops and sells the CyberKnife system (“CyberKnife”), which is an image-guided robotic radiosurgery system used for the treatment of solid tumors anywhere in the body.

 

The Company is incorporated in Delaware, USA and has eleven wholly-owned subsidiaries: Accuray International SARL, located in Geneva, Switzerland, Accuray Europe SAS, located in Paris, France, Accuray UK Ltd, located in London, United Kingdom, Accuray Asia Limited, located in Hong Kong, Accuray Japan KK, located in Tokyo, Japan, Accuray Spain, S.L.U., located in Madrid, Spain, Accuray Medical Equipment (India) Private Ltd., located in New Delhi, India, Accuray Medical Equipment (SEA) Private Limited, located in Singapore, Accuray Medical Equipment (Rus) LLC, located in Moscow, Russia, Accuray Medical Equipment GmbH, located in Munich, Germany and Accuray Tibbi Cihazlar Ve Malzemeler Ithalat Ihracat Anonim Sirketi, located in Istanbul, Turkey.  The purpose of these subsidiaries is to market and service the Company’s products in the respective countries in which they are located.

 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Fiscal Year

 

On June 23, 2009, the Company prospectively changed its fiscal year end from the Saturday closest to June 30, to June 30. Beginning with the fiscal year ended June 30, 2010 (“fiscal 2010”), the Company’s fiscal quarters end on September 30, December 31, March 31 and June 30.

 

Basis of Presentation and Principles of Consolidation

 

The condensed consolidated financial statements include the accounts of the Company and its subsidiaries and the Company’s variable interest entity, Morphormics, Inc. (“Morphormics”).  The Company is considered the primary beneficiary of Morphormics.  All significant inter-company transactions and balances have been eliminated in consolidation.

 

The accompanying condensed consolidated balance sheet as of March 31, 2010 and the condensed consolidated statements of operations for the three and nine-month periods ended March 31, 2010 and 2009 and the condensed consolidated statements of cash flows for the nine-month periods ended March 31, 2010 and 2009 and other information disclosed in the related notes are unaudited.  The condensed consolidated balance sheet as of June 30, 2009 was derived from the Company’s audited consolidated financial statements at that date.  The accompanying condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes contained in the Company’s Annual Report on Form 10-K for the year ended June 30, 2009 filed with the Securities and Exchange Commission (the “SEC”).

 

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 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 and nine months ended March 31, 2010 are not necessarily indicative of the results to be expected for the year ending June 30, 2010 or for any other interim period or for any future year.

 

Use of Estimates

 

The preparation of 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. Actual results could differ from those estimates.

 

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Foreign Currency

 

The Company’s international subsidiaries use their local currencies as their functional currencies. For those subsidiaries, assets and liabilities are translated at exchange rates in effect at the balance sheet date and income and expense accounts at average exchange rates during the year. Resulting translation adjustments are excluded from the determination of net loss and are recorded in accumulated other comprehensive income as a separate component of stockholders’ equity. Net foreign currency exchange transaction gains or losses are included as a component of other income, net, in the Company’s condensed consolidated statements of operations.

 

The majority of the Company’s executed sales contracts are denominated in U.S. dollars.  The CyberKnife system sales contracts denominated in local currency are direct end customer transactions for international customers.  At March 31, 2010, there was one sales contract for CyberKnife system denominated in foreign currency, which was recorded in deferred revenue in the accompanying condensed consolidated balance sheets.

 

Cash and Cash Equivalents

 

The Company considers all highly liquid investments with original maturities of three months or less on the date of purchase to be cash equivalents. Cash equivalents consist of amounts invested in highly liquid investment accounts and money market accounts.

 

Restricted Cash

 

Restricted cash includes amounts deposited as collateral per the terms of contracts with customers requiring that deposited cash amounts be secured via letters of credit until delivery of the CyberKnife system occurs.

 

Marketable Securities

 

The Company’s available-for-sale securities on the condensed consolidated balance sheets include commercial paper, corporate debt and debt issued by U.S. government sponsored enterprises. All marketable securities designated as available-for-sale are reported at estimated fair value, with unrealized gains and losses recorded in stockholders’ equity and included in accumulated other comprehensive income. Realized gains and losses on the sale of available-for-sale marketable securities are recorded in other income, net. The cost of available-for-sale marketable securities sold is based on the specific identification method. Available-for-sale marketable securities with original maturities greater than approximately three months and remaining maturities of one year or less are classified as short-term available-for-sale marketable securities. Available-for-sale marketable securities with remaining maturities of greater than one year are classified as long-term available-for-sale marketable securities. The Company has the ability and the intent to hold these securities for a period of time sufficient to allow for any anticipated recovery in market value.

 

The Company’s trading securities on the condensed consolidated balance sheets consist of (i) auction-rate securities (“ARS”) that are secured by pools of student loans guaranteed by state regulated higher education agencies and reinsured by the U.S. Department of Education and (ii) a put option held in respect to these ARS (see Note 3). Changes in the fair value of the Company’s trading securities are reported in other income, net.

 

Interest, dividends, amortization and accretion of purchase premiums and discounts on all of the Company’s marketable securities are included in other income, net.

 

Other-than-Temporary Impairment Assessment

 

The Company regularly reviews all of its investments for other-than-temporary declines in fair value. The review includes but is not limited to (i) the consideration of the cause of the impairment, (ii) the creditworthiness of the security issuers, (iii) the length of time a security is in an unrealized loss position, and (iv) the Company’s ability to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value.

 

Concentration of Credit Risk and Other Risks and Uncertainties

 

The Company’s cash and cash equivalents are mainly deposited with two 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 and nine months ended March 31, 2010 and 2009, there were no customers that represented 10% or more of total revenue. The following summarizes the accounts receivable from customers in excess of 10% of total accounts receivable:

 

 

 

March 31,

 

June 30,

 

 

 

2010

 

2009

 

Customer A

 

 

11

%

Customer B

 

 

10

%

Customer C

 

10

%

 

Customer D

 

16

%

 

 

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.

 

Inventories

 

Inventories are stated at the lower of cost (on a first-in, first-out basis) or market value. Excess and obsolete inventories are written down based on historical sales and forecasted demand, as judged by management. The Company determines inventory and product costs, which include allocated production overheads, through the use of standard costs.

 

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”), and training. The Company records its revenues net of any value added or sales tax. From time to time, the Company introduces customers to third party financing organizations. No amounts received from these third party financing organizations are at risk.

 

The Company recognizes product revenues for sales of the CyberKnife system, optional upgrades, components and replacement parts and accessories when there is persuasive evidence of an arrangement, the fee is fixed or determinable, collection of the fee is probable and delivery has occurred.  Payments received in advance of product shipment are recorded as customer advances and are recognized as revenue or deferred revenue upon product shipment or installation.

 

For arrangements with multiple elements, the Company allocates arrangement consideration to each element based upon vendor specific objective evidence (“VSOE”) of fair value of the respective elements. VSOE of fair value for each element is based upon the Company’s standard rates charged for the product or service when such product or service is sold separately or based upon the price established by management having the relevant authority when that product or service is not yet being sold separately. When contracts contain multiple elements, and VSOE of fair value exists for all undelivered elements, the Company accounts for the delivered elements, principally the CyberKnife system and optional product upgrades, based upon the residual method. If VSOE of fair value does not exist for all the undelivered elements, all revenue is deferred until the earlier of: (1) delivery of all elements, or (2) establishment of VSOE of fair value for all remaining undelivered elements.

 

The Company assesses the probability of collection based on a number of factors, including past transaction history with the customer and the credit-worthiness of the customer. The Company generally does not request collateral from its customers. If the Company determines that collection of a fee is not probable, the Company will defer the fee and recognize revenue upon receipt of cash.

 

CyberKnife sales with legacy service plans

 

For sales of CyberKnife systems with PCS arrangements that include specified or committed upgrades for which the Company has not established VSOE of fair value, all revenue is deferred. Once all such upgrade obligations have been delivered, all accumulated and deferred revenue is recognized ratably over the remaining life of the PCS arrangement.

 

Sales of additional upgrades as optional extras prior to the delivery of all originally specified upgrade obligations are considered additional elements of the original arrangement and associated revenues are deferred and accounted for as described above. Sales of additional upgrades after delivery of all specified upgrade obligations, as stated in the original contract, are recognized once all revenue recognition criteria applicable to those arrangements are met.

 

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CyberKnife sales with nonlegacy service plans

 

In fiscal year 2006, the Company began selling CyberKnife systems with PCS contracts that only provide for upgrades when and if they become available. The Company has established VSOE of the fair value of PCS in these circumstances. For arrangements with multiple elements that include the CyberKnife system, installation services, training services and a PCS service agreement, the Company recognizes the CyberKnife system and installation services revenue following installation and acceptance of the system by application of the residual method when VSOE of fair value exists for all undelivered elements in the arrangement, including PCS.

 

Other revenue

 

Other revenue primarily consists of research and development contract revenues as well as upgrade services revenues related to the sale of specialized services specifically contracted to provide current technology capabilities for units previously sold through a distributor into the Japan market. Some upgrade sales include elements where VSOE of fair value has not been established for the PCS. As a result, for these sales, associated revenues are deferred and recognized ratably over the term of the PCS arrangement, generally four years.

 

PCS and maintenance services

 

Service revenue for providing PCS, which includes warranty services, extended warranty services, unspecified when and if available product upgrades and technical support is deferred and recognized ratably over the service period, generally one year, until no further obligation exists. At the time of sale, the Company provides for the estimated incremental costs of meeting product warranty if the incremental warranty costs are expected to exceed the related service revenues. Training and consulting service revenues that are not deemed essential to the functionality of the CyberKnife system are recognized as such services are performed.

 

Costs associated with providing PCS and maintenance services are expensed when incurred, except when those costs are related to units where revenue recognition has been deferred. In those cases, the costs are deferred and are recognized over the period of revenue recognition.

 

Distributor sales

 

Sales to third party distributors are evidenced by a distribution agreement governing the relationship together with binding purchase orders or signed quotation on a transaction-by-transaction basis. The Company records revenues from sales of CyberKnife systems to distributors based on a sell-through method where revenue is only recognized upon sell-through of the product to the end user customer and once all other revenue recognition criteria are met including completion of all obligations under the terms of the purchase order or signed quotation. For sales of product upgrades and accessories to distributors, revenue is recognized on either a sell-through or sell-in basis, depending upon the terms of the purchase order or signed quotation and once all revenue recognition criteria are met. These criteria require that persuasive evidence of an arrangement exists, the fees are fixed or determinable, collection of the resulting receivable is probable and there is no right of return.

 

The Company’s agreements with customers and distributors generally do not contain product return rights.

 

Shared ownership program

 

The Company also enters into arrangements under its shared ownership program with certain customers. Agreements under the shared ownership program typically have a term of five years, during which the customer has the option to purchase the CyberKnife system, either at the end of the contractual period or in advance, at the customer’s request, at pre-determined prices. Under the terms of such program, the Company retains title to its CyberKnife system, while the customer has use of the product. The Company generally receives a minimum monthly payment and earns additional revenues from the customer based upon its use of the product. The Company may provide unspecified upgrades to the product during the term of each program when and if available. Upfront non-refundable payments from the customer are deferred and recognized as revenue over the contractual period. Revenues from the shared ownership program are recorded as they become earned and receivable and are included within shared ownership program revenues in the condensed consolidated statements of operations.

 

Under the terms of the shared ownership program, the customer has the option to purchase the CyberKnife system at pre-determined prices based on the period the system has been in use and considering the lease payments already received. Revenue from such sales is recorded in accordance with the Company’s revenue recognition policy, taking into account the PCS and any other elements that might be sold as part of the arrangement.

 

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The CyberKnife systems associated with the Company’s shared ownership program are recorded within property and equipment. Effective April 1, 2009, the estimated useful life of the Company’s placement units was reduced from ten to seven years due to a change in management’s estimate. Depreciation and warranty expenses attributable to the CyberKnife shared ownership systems are recorded within cost of shared ownership program.

 

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 method. The Company recognizes any loss provisions from the total contract in the period such loss is identified.

 

Deferred Revenue and Deferred Cost of Revenue

 

Deferred revenue consists of deferred product revenue, deferred shared ownership program revenue, deferred service revenue and deferred other revenue. Deferred product revenue arises from timing differences between the shipment of product and satisfaction of all revenue recognition criteria consistent with the Company’s revenue recognition policy. Deferred shared ownership program revenue results from the receipt of advance payments that will be recognized ratably over the term of the shared ownership program. Deferred service revenue results from the advance payment for services to be delivered over a contractual service period, usually one year. Service revenue is recognized ratably over the service period. Deferred cost of revenue consists of the direct costs associated with the manufacturing of units, direct service costs for which the revenue has been deferred in accordance with the Company’s revenue recognition policies, and deferred costs associated with research and development contract costs and the Japan upgrade services. Deferred revenue, and associated deferred cost of revenue, expected to be realized within one year are classified as current liabilities and current assets, respectively.

 

Goodwill and Other Purchased Intangibles

 

Goodwill and other intangible assets with indefinite lives are not amortized. Intangible assets with determinable useful lives are amortized on a straight line basis over their useful lives. Goodwill and other intangible assets resulted from the Company’s January 2005 acquisition of the High Energy Systems Division (“HES”) of American Science and Engineering, Inc. (“AS&E”). The Company integrated this operation into its existing manufacturing operation. HES had been the sole source manufacturer of the linear accelerator used in the CyberKnife system. The Company performs an annual test for impairment of goodwill and intangible assets with indefinite lives, and interim tests if indications of potential impairment exist. As of March 31, 2010, there were no indicators of impairment.

 

Stock-Based Compensation

 

The Company recognizes stock-based compensation expense by estimating the fair value of each stock option, restricted stock unit award (“RSU”), or stock issuance through the Company’s employee stock purchase plan (“ESPP”), on the date of grant using the Black-Scholes option-pricing model. The fair market value of the Company’s common stock was calculated at the date of grant by its closing market price as published by the Nasdaq Global Market. Expected volatility was based on the historical volatility of a peer group of publicly traded companies. The expected term of options was based upon the vesting term (for example, 25% on the first anniversary of the vesting start date and 36 equal monthly installments thereafter) and on its partial life history.  The expected term for stock issuances under the ESPP was based upon the offering period of the ESPP.  The risk-free interest rate for the expected term of the option award or issuance was based on the U.S. Treasury Constant Maturity rate. The Company’s forfeiture rate is estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Our estimated annual forfeiture rates are based on our historical forfeiture experience.

 

Income and Other Taxes

 

The Company is required to estimate its income taxes in each of the tax jurisdictions in which it operates prior to the completion and filing of tax returns for such periods.  This process involves estimating actual current tax expense together with assessing temporary differences in the treatment of items for tax purposes versus financial accounting purposes that may create net deferred tax assets and liabilities.  The Company accounts for income taxes under the asset and liability method, which requires, among other things, that deferred income taxes be provided for temporary differences between the tax bases of the Company’s assets and liabilities and their financial statement reported amounts. In addition, deferred tax assets are recorded for the future benefit of utilizing net operating losses, research and development credit carry forwards and temporary differences.

 

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The Company records a valuation allowance to reduce its deferred tax assets to the amount the Company believes is more likely than not to be realized.  Because of the uncertainty of the realization of the deferred tax assets, the Company has recorded a full valuation allowance against its domestic and certain foreign net deferred tax assets.

 

The calculation of unrecognized tax benefits involves dealing with uncertainties in the application of complex global tax regulations. Management regularly assesses the Company’s tax positions in light of legislative, bilateral tax treaty, regulatory and judicial developments in the countries in which the Company does business. Management does not believe there will be any material changes in the unrecognized tax benefits within the next 12 months.

 

Net Income (Loss) Per Common Share

 

Basic net income (loss) per common share is calculated based on the weighted-average number of shares of our common stock outstanding during the period. Diluted net income (loss) per common share is calculated based on the weighted-average number of shares of our common stock outstanding and other dilutive securities outstanding during the period. The potential dilutive shares of our common stock resulting from the assumed exercise of outstanding stock options and equivalents are determined under the treasury stock method. Shares used in the computation on net income (loss) per common share are as follows:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

March 31,

 

March 31,

 

 

 

2010

 

2009

 

2010

 

2009

 

Weighted-average shares - basic

 

57,851,344

 

55,724,222

 

57,352,458

 

55,137,943

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Stock options and restricted stock units

 

2,618,750

 

3,047,818

 

 

 

Weighted-average shares - diluted

 

60,470,094

 

58,772,040

 

57,352,458

 

55,137,943

 

 

For the three months ended March 31, 2010 and 2009, 3,984,761 and 4,335,496 of anti-dilutive shares were excluded from the calculation of dilutive securities.

 

Comprehensive Income (Loss)

 

Comprehensive income (loss) is comprised of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) consists of foreign currency translation adjustments and unrealized gains and losses on investments that have been excluded from the determination of net income (loss). Comprehensive income (loss) for the three and nine months ended March 31, 2010 and 2009 is as follows (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

March 31,

 

March 31,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net income (loss)

 

$

2,272

 

$

1,216

 

$

(2,179

)

$

(613

)

Unrealized gain (loss) on investments

 

(186

)

(401

)

(333

)

1,212

 

Foreign currency translation adjustments

 

(22

)

(24

)

(21

)

(31

)

Comprehensive income (loss)

 

$

2,064

 

$

791

 

$

(2,533

)

$

568

 

 

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.

 

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The Company markets its products in the United States and internationally through its direct sales force and indirect distribution channels. 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

 

Nine Months Ended

 

 

 

March 31,

 

March 31,

 

 

 

2010

 

2009

 

2010

 

2009

 

Americas (including Puerto Rico)

 

$

30,243

 

$

49,074

 

$

106,116

 

$

126,890

 

Europe

 

17,161

 

10,045

 

42,097

 

22,571

 

Asia (excluding Japan)

 

3,280

 

1,147

 

5,026

 

15,901

 

Japan

 

1,256

 

1,035

 

6,598

 

9,433

 

Total

 

$

51,940

 

$

61,301

 

$

159,837

 

$

174,795

 

 

Recent Accounting Pronouncements

 

In February 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2010-09, Amendments to Certain Recognition and Disclosure Requirements. ASU No. 2010-09 amends FASB Accounting Standards Codification (“ASC”) 855 and removes the requirement to disclose the date through which management evaluated subsequent events in the financial statements. This ASU is effective immediately for all financial statements that have not been issued or have not yet become available to be issued. The adoption of ASU 2010-09 did not have a material impact on the Company’s condensed consolidated financial statements.

 

In January 2010, the FASB issued ASU No. 2010-06, Improving Disclosures about Fair Value Measurements. ASU No. 2010-06 amends FASB ASC 820 and clarifies and provides additional disclosure requirements related to recurring and non-recurring fair value measurements and employers’ disclosures about postretirement benefit plan assets. This ASU is effective for interim and annual reporting periods beginning after December 15, 2009. The adoption of ASU 2010-06 did not have a material impact on the Company’s condensed consolidated financial statements.

 

In October 2009, the FASB issued ASU 2009-13, Multiple-Deliverable Revenue Arrangements, (amendments to ASC Topic 605, Revenue Recognition) (“ASU 2009-13”) (formerly EITF Issue 08-1) and ASU 2009-14, Certain Arrangements That Include Software Elements, (amendments to FASB ASC Topic 985, Software) (“ASU 2009-14”) (formerly Emerging EITF 09-3). ASU 2009-13 requires entities to allocate revenue in an arrangement using estimated selling prices of the delivered goods and services based on a selling price hierarchy. The amendments eliminate the residual method of revenue allocation and require revenue to be allocated using the relative selling price method. ASU 2009-14 removes tangible products from the scope of software revenue guidance and provides guidance on determining whether software deliverables in an arrangement that includes a tangible product are covered by the scope of the software revenue guidance. ASU 2009-13 and ASU 2009-14 should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. The Company anticipates adopting ASU 2009-13 and ASU 2009-14 in fiscal 2011 and is currently assessing the impact of the adoption of ASU 2009-13 or ASU 2009-14 on the Company’s condensed consolidated financial statements.

 

In June 2009, the FASB issued ASC 810-10, Consolidation of Variable Interest Entities (“ASC 810-10”) (formerly SFAS No. 167, Amendments to FASB Interpretation No. 46(R)). ASC 810-10 eliminates the quantitative approach previously required for determining the primary beneficiary of a variable interest entity and to require ongoing qualitative reassessments of whether an enterprise is the primary beneficiary of a variable interest entity. ASC 810-10 requires additional disclosures about an enterprise’s involvement in variable interest entities. ASC 810-10 is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. The adoption of ASC 810-10 is not expected to have a material impact on the Company’s condensed consolidated financial statements.

 

In June 2009, the FASB issued ASC 860-10, Transfers and Servicing (“ASC 860-10”) (formerly SFAS No. 166, Accounting for Transfers of Financial Assets, an amendment to SFAS No. 140). The new standard eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets, and requires additional disclosures in order to enhance

 

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information reported to users of financial statements by providing greater transparency about transfers of financial assets, including securitization transactions, and an entity’s continuing involvement in and exposure to the risks related to transferred financial assets. ASC 860-10 is effective for fiscal years beginning after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. The adoption of ASC 860-10 is not expected to have a material impact on the Company’s condensed consolidated financial statements.

 

3. FINANCIAL INSTRUMENTS

 

The Company is permitted to measure many financial instruments and certain other items at fair value, with changes in fair value recognized in earnings each reporting period. The election, called the fair value option, enables entities to achieve an offset accounting effect for changes in fair value of certain related assets and liabilities without having to apply complex hedge accounting provisions. In November 2008, the Company entered into an agreement (“Rights Agreement”) with UBS, which provides the Company with ARS Rights (“Rights”) to sell its ARS at par value to UBS at any time during the period June 30, 2010 through July 2, 2012. These Rights are a separate freestanding instrument accounted for separately from the ARS, and are registered, nontransferable securities accounted for as a put option initially recorded at fair value. Under the Rights Agreement, UBS may, at its discretion, purchase or sell the ARS at any time through July 2, 2012 without prior notice to the Company and must pay the Company par value for the ARS within one day of the sale transaction settlement. The Company agreed to release UBS from certain potential claims related to its marketing and sale of the ARS. Additionally, UBS offered a “no net cost” loan to the Company for up to 75% of par value of the ARS as determined by UBS until June 30, 2010 (See Note 9).  The Company expects to exercise the option and sell all ARS holdings on June 30, 2010.  Liquidating these holdings will result in a realization of previously unrecognized gains/losses, which the Company does not expect to have a material effect on the financial statements.

 

The Company elected fair value accounting for the put option recorded in connection with the Rights Agreement. This election was made in order to mitigate volatility in earnings caused by accounting for the purchased put option and underlying ARS under different methods. The initial election of fair value resulted in a gain included in “Other income, net” for the put option which is recorded in trading securities on the accompanying condensed consolidated balance sheets.

 

Due to UBS’s ability to sell the ARS at any time under the Rights Agreement, the ARS previously reported as available-for-sale have been transferred to trading securities on the condensed consolidated balance sheets. Due to the change in classification to trading securities, at the time of entering into the Rights Agreement, the Company transferred the previously accumulated unrealized loss of $3.8 million from “Accumulated other comprehensive income (loss)” to “Other income, net” and recorded additional net unrealized gains of $3.3 million relating to the change in fair value of the trading securities from November 2008 through March 31, 2010 in “Other income, net”. At March 31, 2010 and June 30, 2009, the total fair value of the ARS was $21.5 million and $20.7 million, respectively, net of $0.4 million and $1.7 million, respectively, of unrealized losses.

 

Additionally, the Company recorded unrealized gains of $3.3 million related to the fair value of the put option at the time it entered into the Rights Agreement and recorded unrealized losses relating to the change in fair value of the put option beginning in November 2008. During the three and nine months ended March 31, 2010, the Company recorded a total unrealized loss of $0.2 million and $1.0 million, respectively, for a total fair value of the put option of $0.4 million as of March 31, 2010. During the three months ended March 31, 2009, the Company recorded a total unrealized loss of $0.1 million for a total fair value of the put option of $3.2 million as of March 31, 2009. During the three and nine months ended March 31, 2010, $0.2 million and $1.2 million, respectively, of unrealized gain in fair value of the ARS resulted in a net unrealized gain of $0.1 million and $0.3 million for the three and nine month period  to “Other income, net”.  During the three months ended March 31, 2009, $0.2 million of total unrealized gain in fair value of the ARS resulted in a total net unrealized gain of $0.1 million to “Other income, net”.  During the three and nine months ended March 31, 2010, UBS redeemed $0.2 million and $0.4 million, respectively, of the ARS, which generated realized gains that were not material. During the three months ended March 31, 2009, UBS did not redeem any of the ARS.

 

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 sets forth by level within the fair value hierarchy the Company’s financial instruments that were accounted for at fair value on a recurring basis at March 31, 2010 and June 30, 2009, according to the valuation techniques the Company used to determine their fair values (in thousands):

 

 

 

Fair Value at

 

Fair Value Measurements
Using Inputs Considered as

 

 

 

March 31, 2010

 

Level 1

 

Level 2

 

Level 3

 

Money market funds

 

$

3,776

 

$

3,776

 

$

 

$

 

Corporate notes

 

30,568

 

 

30,568

 

 

Commercial paper

 

29,264

 

 

29,264

 

 

U.S. government and governmental agency obligations

 

32,869

 

 

32,869

 

 

Auction-rate securities

 

21,490

 

 

 

21,490

 

Put option

 

370

 

 

 

370

 

Total

 

$

118,337

 

$

3,776

 

$

92,701

 

$

21,860

 

 

 

 

Fair Value at

 

Fair Value Measurements
Using Inputs Considered as

 

 

 

June 30, 2009

 

Level 1

 

Level 2

 

Level 3

 

Money market funds

 

$

19,549

 

$

19,549

 

$

 

$

 

Corporate notes

 

27,251

 

 

27,251

 

 

Commercial paper

 

21,865

 

 

21,865

 

 

U.S. government and governmental agency obligations

 

50,763

 

 

50,763

 

 

Auction-rate securities

 

20,669

 

 

 

20,669

 

Put option

 

1,338

 

 

 

1,338

 

Total

 

$

141,435

 

$

19,549

 

$

99,879

 

$

22,007

 

 

Investments in marketable securities classified as available-for-sale by security type at March 31, 2010 and June 30, 2009, consisted of the following (in thousands):

 

 

 

March 31, 2010

 

 

 

 

 

Gross Unrealized

 

Gross Unrealized

 

 

 

 

 

Amortized Cost

 

Gains

 

Losses

 

Fair Value

 

Short-term investments:

 

 

 

 

 

 

 

 

 

Commercial paper

 

$

24,456

 

$

8

 

$

 

$

24,464

 

US Corporate debt

 

28,588

 

142

 

(20

)

28,710

 

Government-sponsored enterprises

 

28,375

 

17

 

(24

)

28,368

 

Total short-term investments

 

81,419

 

167

 

(44

)

81,542

 

Long-term investments:

 

 

 

 

 

 

 

 

 

US Corporate debt

 

1,846

 

11

 

 

1,857

 

Government-sponsored enterprises

 

4,500

 

2

 

 

4,502

 

Total long-term investments

 

6,346

 

13

 

 

6,359

 

Total short and long-term investments

 

$

87,765

 

$

180

 

$

(44

)

$

87,901

 

 

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Table of Contents

 

 

 

June 30, 2009

 

 

 

 

 

Gross Unrealized

 

Gross Unrealized

 

 

 

 

 

Amortized Cost

 

Gains

 

Losses

 

Fair Value

 

Short-term investments:

 

 

 

 

 

 

 

 

 

Commercial paper

 

$

21,869

 

$

14

 

$

(18

)

$

21,865

 

US Corporate debt

 

9,993

 

81

 

 

10,074

 

Government-sponsored enterprises

 

32,456

 

239

 

 

32,695

 

Total short-term investments

 

64,318

 

334

 

(18

)

64,634

 

Long-term investments:

 

 

 

 

 

 

 

 

 

US Corporate debt

 

17,094

 

103

 

(20

)

17,177

 

Government-sponsored enterprises

 

18,001

 

67

 

 

18,068

 

Total long-term investments

 

35,095

 

170

 

(20

)

35,245

 

Total short and long-term investments

 

$

99,413

 

$

504

 

$

(38

)

$

99,879

 

 

All of the Company’s investments with continuous unrealized losses have been in an unrealized loss position for less than twelve months at March 31, 2010. The Company has determined that the gross unrealized losses on its marketable securities at March 31, 2010 were temporary in nature.

 

The table below presents a reconciliation of all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3). The Company classifies financial instruments in Level 3 of the fair value hierarchy when there is reliance on at least one significant unobservable input to the valuation model. In addition to these unobservable inputs, the valuation models for Level 3 financial instruments typically also rely on a number of inputs that are readily observable either directly or indirectly. Thus, the gains and losses presented below include changes in the fair value related to both observable and unobservable inputs (in thousands).

 

 

 

Three Months

 

Nine Months

 

 

 

Ended

 

Ended

 

 

 

March 31, 2010

 

March 31, 2010

 

Beginning balance

 

$

22,011

 

$

22,007

 

Realized gain on auction rate securities included in earnings (1)

 

 

5

 

Unrealized gain on auction rate securities included in earnings (1)

 

224

 

1,216

 

Redemption of auction rate securities

 

(175

)

(400

)

Unrealized loss on put option included in earnings (1)

 

(200

)

(968

)

Balance at March 31, 2010

 

$

21,860

 

$

21,860

 

 


(1) Represents the amount of total gains (losses) for the period included in earnings relating to assets still held on March 31, 2010.

 

The following methods and assumptions were used to estimate the fair value of each class of financial instrument:

 

Money market funds. Money market funds are classified as cash and cash equivalents on the Company’s consolidated balance sheets.

 

Corporate notes. Corporate notes are floating-rate obligations that are payable on demand. These are classified as available-for-sale within short-term marketable securities on the Company’s condensed consolidated balance sheets. The market approach was used to value the Company’s variable-rate demand notes. The Company classified these securities as Level 2 instruments due to either its usage of observable market prices in less active markets or, when observable market prices were not available, its use of non-binding market prices that are corroborated by observable market data or quoted market prices for similar instruments.

 

Commercial paper. Commercial paper is an unsecured, short-term debt instrument issued by corporations and financial institutions that generally mature within 270 days. The balance of $24.5 million and $21.9 million held as of March 31, 2010 and June 30, 2009, respectively, in commercial paper is classified as short-term marketable securities on the Company’s condensed consolidated balance sheets. The portion in cash and cash equivalents of $4.8 million represents highly liquid debt instruments with insignificant interest rate risk and original maturities of ninety days or less. The market approach was used to value the Company’s commercial paper. The Company classified these securities as Level 2 instruments due to either its usage of observable market prices in less active markets or, when observable market prices were not available, its use of non-binding market prices that are corroborated by observable market data or quoted market prices for similar instruments.

 

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U.S. government and governmental agency obligations.  U.S. government and governmental agency obligations are issued by state and local governments and other governmental entities such as authorities or special districts that vary in their maturity period. These are classified as short-term and long-term marketable securities on the Company’s condensed consolidated balance sheets. The market approach was used to value the Company’s U.S. government and governmental agency obligations. The Company classified these securities as Level 2 instruments due to either its usage of observable market prices in less active markets or, when observable market prices were not available, its use of non-binding market prices that are corroborated by observable market data or quoted market prices for similar instruments.

 

Auction-rate securities.  As of March 31, 2010, there was insufficient observable market information available to determine the fair value of the Company’s ARS. Prior to December 31, 2008, the Company estimated Level 3 fair values for these securities based on the financial institutions broker’s valuations. The financial institution broker valued student loan ARS as floating rate notes with three pricing inputs: the coupon, the current discount margin or spread, and the maturity. The coupon was generally assumed to equal the maximum rate allowed under the terms of the instrument, the current discount margin was based on an assessment of observable yields on instruments bearing comparable risks, and the maturity was based on an assessment of the terms of the underlying instrument and the potential for restructuring the ARS. The primary unobservable input to the valuation was the maturity assumption which was set at five years for the majority of ARS instruments. Through January 6, 2008, the ARS were valued at par value due to the frequent resets that historically occurred through the auction process.

 

As of December 31, 2008, the Company determined Level 3 fair value using an income approach. The pricing assumptions for the ARS included the coupon rate, the estimated time to liquidity, current market rates for publicly traded corporate debt of similar credit rating and an adjustment for lack of liquidity. The coupon rate was assumed to equal the stated maximum auction rate being received, which is the lesser of (i) an average trailing twelve month yield for the ARS that is equal to the average trailing twelve month 91-day U.S. Treasury rate plus 1.20% or 1.50% premium according to provisions outlined in each security’s agreement, (ii) the one-month LIBOR rate as of the auction date plus 1.5%, or (iii) a maximum interest rate of either 17% or 18% (specific to each ARS). The estimated time to liquidity was 3.25 years based on (i) expectations from industry brokers for liquidity in the market and (ii) the period over which UBS and other broker-dealers that had issued ARS have agreed to redeem certain ARS at par value.

 

The put option gives the Company the right to sell the ARS to UBS for a price equal to par value during the period June 30, 2010 to July 2, 2012, providing liquidity for the ARS sooner than the estimated five years. As the Company expects to liquidate all ARS holdings by June 30, 2010, the value of the put option lies in (i) the ability to sell the securities thereby creating liquidity approximately two years before the ARS market is expected to become liquid and (ii) the avoidance of receiving below-market coupon rate while the security is illiquid and auctions are failing. The fair value of the put option represents the difference between the ARS with an estimated time to liquidity of 3.25 years and the ARS with an estimated time to liquidity of three months as the put option allows for the acceleration of liquidity and the avoidance of a below market coupon rate over the three month time period.

 

4. BALANCE SHEET COMPONENTS

 

Accounts receivable, net

 

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

 

 

 

March 31,

 

June 30,

 

 

 

2010

 

2009

 

Accounts receivable

 

$

36,186

 

$

36,539

 

Unbilled fees and services

 

170

 

372

 

 

 

36,356

 

36,911

 

Less: Allowance for doubtful accounts

 

(35

)

(484

)

Accounts receivable, net

 

$

36,321

 

$

36,427

 

 

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Table of Contents

 

Inventories

 

Inventories consist of the following (in thousands):

 

 

 

March 31,

 

June 30,

 

 

 

2010

 

2009

 

Raw materials

 

$

12,341

 

$

12,172

 

Work-in-process

 

8,970

 

13,006

 

Finished goods

 

6,920

 

3,731

 

Total inventories

 

$

28,231

 

$

28,909

 

 

Property and Equipment, net

 

Property and equipment consist of the following (in thousands):

 

 

 

March 31,

 

June 30,

 

 

 

2010

 

2009

 

Furniture and fixtures

 

$

3,660

 

$

3,404

 

Computer and office equipment

 

8,057

 

7,982

 

Leasehold improvements

 

7,751

 

7,676

 

Machinery and equipment

 

15,212

 

14,097

 

CyberKnife shared ownership systems

 

3,761

 

3,725

 

Construction In Progress

 

1,100

 

 

 

 

39,541

 

36,884

 

Less: Accumulated depreciation and amortization

 

(26,299

)

(21,818

)

Property and equipment, net

 

$

13,242

 

$

15,066

 

 

Depreciation and amortization expense related to property and equipment for the three and nine months ended March 31, 2010 was $1.6 million and $5.3 million, respectively. Depreciation and amortization expense related to property and equipment for the three and nine months ended March 31, 2009 was $1.6 million and $4.8 million, respectively. Accumulated depreciation related to the CyberKnife systems attributable to the shared ownership program as of March 31, 2010 and June 30, 2009 was $1.9 million and $1.0 million, respectively.

 

Of the $1.1 million recorded in construction in process, $0.7 million relates to the Company’s implementation of a new enterprise resource planning information system, which will replace its existing system, and includes capitalized costs relating to license and consulting fees.

 

5. INVESTMENT

 

On July 29, 2008, the Company and Morphormics entered into a Stock Purchase Agreement pursuant to which the Company agreed to purchase 120,000 shares of Morphormics Series C Preferred Stock at $12.50 per share, for a total purchase price of $1.5 million. In exchange, Morphormics granted the Company a non-exclusive worldwide license to integrate several of its software products into the Company’s treatment planning software. The equity investment afforded the Company a voting interest of approximately 18% in Morphormics. The Company’s equity is considered to be at risk and is deemed not sufficient to finance Morphormics’ current product development activities without additional subordinated financial support. In addition, the Company is deemed to be Morphormics’ primary beneficiary; therefore, it would absorb a majority of expected losses. The Company consolidates Morphormics in its financial results. The consolidation of Morphormics’ assets and liabilities did not have a material effect on the Company’s consolidated balance sheets at March 31, 2010 or June 30, 2009. Subsequent to July 29, 2008, the Company has recorded cumulative losses of $1.4 million on its investment in Morphormics. The remaining $0.1 million of the Company’s investment remains at risk as of March 31, 2010.

 

6. CONTINGENCIES

 

Litigation

 

On July 22, 2009, a securities class action lawsuit was filed in the U.S. District Court for the Northern District of California against the Company and certain of its current and former directors and officers. On August 7, 2009 and August 9, 2009, two securities class action complaints, both similar to the one filed on July 22, 2009, were filed against the same defendants in the same court. These three actions were consolidated. The consolidated complaint generally alleges that the Company and the individual defendants made false or misleading public statements regarding the Company’s operations and seek unspecified monetary damages and other relief.

 

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On August 5, 2009, a shareholder derivative lawsuit was filed in Santa Clara County Superior Court against certain of the Company’s current and former officers and directors. The Company is named as a nominal defendant. The complaint generally alleges that the defendants breached their fiduciary duties by misrepresenting and/or failing to disclose material information regarding the Company’s business and financial performance, and seeks unspecified monetary damages and other relief.  On February 25, 2010, the plaintiff dismissed the action without prejudice.

 

On November 24, 2009, a shareholder derivative lawsuit was filed in the U.S. District Court for the Northern District of California against certain of the Company’s current and former officers and directors.  The Company is named as a nominal defendant.  Three other shareholder derivative lawsuits were filed in the same court on November 30, 2009, December 1, 2009 and March 16, 2010.  These actions have been consolidated.  The amended consolidated complaint generally alleges that the defendants breached their fiduciary duties by misrepresenting and/or failing to disclose material information regarding the Company’s business and financial performance, and that certain defendants also violated federal and California securities laws.  The amended consolidated complaint seeks unspecified monetary damages and other relief.

 

On September 3, 2009, Best Medical International, Inc. (“Best Medical”) filed a lawsuit against the Company claiming 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. They are seeking monetary 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.

 

As of March 31, 2010, the Company has not recorded any liabilities for the above referenced lawsuits as a loss is not considered probable or estimable.

 

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 recorded no liability associated with this indemnification, as it is not aware of any pending or threatened actions that are probable losses as of March 31, 2010.

 

7. STOCK-BASED COMPENSATION

 

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

 

 

 

Three Months Ended
March 31,

 

Nine Months Ended
March 31,

 

 

 

2010

 

2009

 

2010

 

2009

 

Cost of revenue

 

$

492

 

$

622

 

$

1,168

 

$

1,801

 

Selling and marketing

 

(84

)

538

 

1,379

 

2,518

 

Research and development

 

636

 

797

 

1,937

 

2,330

 

General and administrative

 

839

 

1,167

 

3,753

 

5,027

 

 

 

$

1,883

 

$

3,124

 

$

8,237

 

$

11,676

 

 

During the three months ended March 31, 2010 we revised our estimate of the rate of forfeitures to better reflect actual forfeitures which have been higher than we originally estimated. This resulted in a $0.8 million reduction in overall stock-based compensation expense in the quarter. At March 31, 2010 and June 30, 2009, capitalized stock-based compensation costs of $182,000 and $456,000, respectively, were included as components of inventory.

 

8. RELATED PARTY TRANSACTIONS

 

The Company’s former Chief Executive Officer, Dr. John R. Adler, Jr. was a member of the Company’s Board of Directors until his resignation effective July 19, 2009, and is a member of the faculty at Stanford, where he holds the position of Professor of Neurosurgery and Radiation Oncology. Effective July 20, 2009, Dr. Adler was no longer a related party of the Company.

 

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The Company recognized related party revenue of $229,000 and $656,000 during the three and nine months ended March 31, 2009, respectively, relating to products and services provided to Stanford.  The Company recorded $29,000 and $141,000 of expense during the three and nine months ended March 31, 2009, respectively, relating to research grants with Stanford to support customer studies related to the Company’s CyberKnife systems. At June 30, 2009, $209,000 was recorded as deferred revenue and advances relating to related party payments made by Stanford. At June 30, 2009, $9,000 was due from Stanford.

 

In April 2008, the Company entered into a consulting agreement with Dr. Adler, whereby Dr. Adler was entitled to receive a maximum compensation of $167,100 per year, payable in quarterly installments at the beginning of each quarter beginning on April 1, 2008.

 

In April 2009, the Company entered into a consulting agreement with Dr. Adler that terminated the prior consulting agreement discussed above. Under the new consulting agreement, Dr. Adler was entitled to receive maximum compensation of $168,100 per year, payable in quarterly installments at the beginning of each quarter beginning on April 1, 2009. This agreement had a term of one year, however, Dr. Adler terminated this agreement effective March 20, 2010. The Company recognized consulting expense for Dr. Adler in the amount of $42,000 and $125,000 for the three and nine months ended March 31, 2009.

 

9. SECURED CREDIT LINE

 

In November 2008, the Company obtained a line of credit with UBS in conjunction with the Rights Agreement (see Note 3). The line of credit is due on demand and allows for borrowings of up to 75% of par value of the Company’s ARS. The line of credit is secured by the Company’s ARS, which have been pledged as collateral. Advances under this agreement bear interest with interest payments payable monthly. No borrowings were outstanding during the three or nine months ended March 31, 2010.

 

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 March 31, 2010 and results of operations for the three and nine months ended March 31, 2010 and 2009 should be read together with our condensed consolidated financial statements and related notes included elsewhere in this report.  This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. We urge you not to place undue reliance on these forward-looking statements, which speak only as of the date of this report.  All forward-looking statements included in this report are based on information available to us on the date of this report, and we assume no obligation to update any forward-looking statements contained in this report. These forward-looking statements involve risks and uncertainties, and our actual results, performance, or achievements could differ materially from those expressed or implied by the forward-looking statements on the basis of several factors, including those that we discuss in Risk Factors, set forth in Part I, Item 1A, of our annual report on Form 10-K for the fiscal year ended June 30, 2009 and supplemented by the Risk Factors set forth in Part II, Item 1A of this quarterly report on Form 10-Q. We encourage you to read those sections carefully.

 

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

 

Overview

 

We have developed what we believe to be the first and only commercially available intelligent robotic radiosurgery system, the CyberKnife system, designed to treat solid tumors anywhere in the body as an alternative to traditional surgery. The CyberKnife system combines continuous image-guidance technology with a compact linear accelerator that has the ability to move in three dimensions according to the treatment plan. Our image-guidance technology enables the system to continuously acquire images to track a tumor’s location and transmit any position corrections to the robotic arm prior to delivery of each dose of radiation. Our compact linear accelerator (“linac”) is a compact radiation treatment device that uses microwaves to accelerate electrons to create high-energy X-ray beams to destroy the tumor. This combination, which we refer to as intelligent robotics, extends the benefits of radiosurgery to the treatment of tumors anywhere in the body. The CyberKnife system autonomously tracks, detects and corrects for tumor and patient movement in real-time during the procedure, enabling delivery of precise, high dose radiation typically with sub-millimeter accuracy. The CyberKnife procedure requires no anesthesia, can be performed on an outpatient basis and allows for the treatment of patients who otherwise would not have been treated with radiation or who may not have been good candidates for surgery. In addition, the CyberKnife procedure is designed to avoid many of the potential risks and complications that are associated with other treatment options and is more cost effective than traditional surgery.

 

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In July 1999, we obtained 510(k) clearance from the United States Food and Drug Administration, or FDA, to market the CyberKnife system for the treatment of tumors and certain other conditions in the head, neck and upper spine. In August 2001, we received FDA clearance for the treatment of tumors anywhere in the body where radiation treatment is indicated. In September 2002, we received a CE mark for the sale of the CyberKnife system in Europe. CE mark is an international symbol that represents adherence to certain essential principles of safety and effectiveness mandated in the European Medical Device Directive.  We received approval for full-body treatment in Japan in June 2008; previously our CyberKnife regulatory approvals in Japan were limited to treatment for indications in the head and neck. The CyberKnife system has also been approved for various indications in Korea, Taiwan, China and other countries. To date, our CyberKnife system has been used to deliver more than 80,000 patient treatments.

 

In the United States, we sell to customers, including hospitals and stand-alone treatment facilities, directly through our sales organization. Outside the United States, we sell to customers in over 80 countries directly and through distributors. We have sales and service offices in Paris, France, Hong Kong, China, Tokyo, Japan, Madrid, Spain, New Delhi, India, Singapore, Moscow, Russia, Munich, Germany, Istanbul, Turkey and London, UK. As of March 31, 2010, we had 41 employees in our sales organization.

 

Our CyberKnife systems are either sold to our customers or placed with our customers pursuant to our shared ownership program. As of March 31, 2010, we had 196 CyberKnife systems installed at customer sites, including 194 sold and two pursuant to our shared ownership program. Of the 196 systems installed, 125 are in the Americas, 44 are in Asia and 27 are in Europe.

 

In addition to selling the CyberKnife system to customers through direct sales, we offer alternative arrangements to customers who may not have the financial means to purchase a CyberKnife system. For example, under our shared ownership program, we retain title to the CyberKnife system while the customer has use of the system. Our shared ownership contracts generally require a minimum monthly payment from the customer, and we may earn additional revenue through the use of the system at the site. Generally, minimum monthly payments are equivalent to the revenue generated from treating three to four patients per month, and any revenue received from additional patients is shared between us and the customer. We expect to continue to offer our shared ownership program to new customers. The shared ownership program typically has a term of five years, during which the customer has the option to purchase the system at pre-determined prices.

 

We manufacture and assemble our CyberKnife systems at our manufacturing facility in Sunnyvale, California. We purchase major components, including the robotic manipulator, the treatment table or robotic couch, the magnetron, which creates the microwaves for use in the linear accelerator, the imaging cameras and the computers, from outside suppliers, some of which are single source. Our reliance on single source suppliers could harm our ability to meet demand for our products in a timely and cost effective manner. However, in most cases, if a supplier were unable to deliver these components, we believe that we would be able to find other sources for these components subject to any regulatory qualifications, if required. We would, however, likely suffer some delays in qualifying any new supplier.  We manufacture certain other electronic and electrical subsystems, including the linear accelerator. We then assemble and integrate these components with our proprietary software and perform testing prior to shipment to customer sites.

 

We generate revenue from sales of products and by providing ongoing services and upgrades to customers following installation of the CyberKnife system. The current United States price for the CyberKnife system typically includes initial training, installation, and a one-year warranty. We also offer optional hardware and software when and if available, technical enhancements and upgrades to the CyberKnife system, as part of our multiyear service plans. Currently, our most comprehensive service plan is our Diamond Elite multiyear service plan, or Diamond plan. Under our Diamond plan, customers are eligible to receive up to two upgrades per year, when and if available. Prior to introducing our Diamond plan, we offered our Platinum service plan which provided specified future upgrade obligations. For systems sold with a Platinum service plan, all revenue, including CyberKnife product and service revenue, is deferred until all upgrade obligations have been satisfied and then is recognized ratably over the remaining life of the Platinum service contract. As of March 31, 2010 and 2009, 141 out of 153 and 96 out of 128 of our customers had purchased non-Platinum service plans.

 

The CyberKnife procedure is currently covered and reimbursed by Medicare and other governmental and non-governmental third-party payors. Medicare coverage currently exists in the hospital outpatient setting and in the free-standing clinic setting. For calendar year 2010, the national unadjusted average Medicare payment rates under Healthcare Common Procedure Coding System, or HCPCS, are $3,572 under code G0339, the billing code for the first treatment, and $2,488 under code G0340, the billing code for each of the second through fifth treatments, approximately six percent and four percent less than 2009 payment rates, respectively. Payment for the free-standing clinic setting is governed by the final Medicare Physician Fee Schedule. For 2010, payment for CyberKnife procedures in the freestanding clinic settings for first and subsequent treatments is set by local Medicare carriers and rates may vary from low payment to a payment rate exceeding the hospital outpatient payment rates.  We are currently evaluating the impact that the health care legislation bill, HR 4872, signed into law in March of 2010 may have on Medicare reimbursement rates.

 

In addition to Medicare reimbursement to hospitals and clinics, physicians receive reimbursement for their professional services in the hospital outpatient setting and the free-standing clinic setting. Payment to physicians is based on the Medicare Physician Fee Schedule, and payment amounts are updated on an annual basis. For 2010, Medicare adjusted reimbursement rates for the Current Procedural Terminology, or CPT, code series describing the surgeon’s role in the delivery of CyberKnife cranial and spinal procedures beginning with 61796 and 63620 to varying degrees. For example, the rate for treating five simple cranial lesions was reduced by less than one percent, and the rate for treating one complex cranial lesion was increased by more than 40%.

 

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Table of Contents

 

Radiosurgery procedures in other anatomies require other surgeons to bill unlisted CPT codes with no assigned payment rates. Payment rates for unlisted codes are set by the local Medicare carrier and rates may vary from no payment to rates equivalent to the comparable CPT rates for the series beginning with 61796 and 63620. Coding for other physicians (primarily radiation oncologists) involved in the delivery of CyberKnife treatment increased by one percent.

 

In November of 2009, we announced the introduction of the CyberKnife VSI ™ system, which allows physicians to perform conventionally fractioned robotic image guided intensity-modulated radiation therapy, or Robotic IMRTTM, in addition to Robotic Stereotactic Radiosurgery procedures.  Reimbursement for Robotic IMRT is expected to be similar to conventional IMRT.

 

Our future success will depend in large part on our ability to maintain and increase our position in the market. To compete successfully, we will need to continue to demonstrate the advantages of our products and technologies over alternative procedures, products and technologies, and convince physicians and other healthcare decision makers of the advantages of our products and technologies. Our business and sales and installation cycle does not immediately create recognizable revenue. As such, we must invest in sales and marketing activities generally 1 to 2 years before we are able to generate revenue from those activities. Our ability to achieve and maintain long-term profitability is largely dependent on our ability to successfully market and sell the CyberKnife system and to control our costs and effectively manage our growth.

 

Financial Condition

 

Direct Sales and Installation Cycle

 

The CyberKnife system has a long sales and installation cycle because it is a major capital purchase for our typical customer and requires the approval of senior management at purchasing institutions. The sales and installation cycle is typically 1 to 2 years in duration and involves multiple steps. The cycle begins with customer meetings with sales and products specialists, and ends upon resolution of all contingencies and either upon shipment, if a customer is responsible for installation, or upon installation by us. Prior to installation, a purchasing institution must typically obtain a radiation device installation permit, and in some cases, a certificate of need or CON, both of which must be granted by state and local government bodies and can add time to the cycle. Recently, as a result of healthcare cost considerations and sensitivity to the cost of major capital equipment items, some state CON boards have become more stringent in the evaluation of CON applications. This trend, if it continues, may make the CON process more protracted and uncertain. In addition, the purchasing institution must build a radiation shielded facility or upgrade an existing facility to house the CyberKnife system. We generally receive a deposit at the time the purchase agreement is entered into, or shortly thereafter, an additional payment prior to shipment and the remaining balance for the sale of the CyberKnife system after delivery and installation. The customer also typically selects a service plan at the time of signing a CyberKnife system purchase agreement and enters into the service plan agreement prior to installation of the system.

 

Upon installation, we typically recognize the CyberKnife system sale price less the fair value of up to two years of service and training. We recognize the fair value of the first year of service as revenue pro rata over the twelve months following installation and training as delivered. In addition, if the customer has purchased our Diamond plan and assuming annual renewals, we would receive payment at the beginning of each of the second, third, fourth and fifth years of the multiyear service plan and recognize that revenue pro rata over each year.

 

Legacy Service Plans

 

Prior to introducing our Diamond plan, we offered a Platinum Elite multiyear service plan, or Platinum plan. This legacy service plan was structured so that we had an obligation to deliver two upgrades per year over the course of the multiyear service plan. If we fail to deliver the upgrades, our customers were entitled to receive a refund of up to $100,000 for each upgrade not offered. To date, no refunds have been required pursuant to the Platinum plan. Beginning in November 2005, we phased out offering this legacy service plan to new customers.

 

The Platinum plan obligates us to deliver up to two upgrades per year during the term of the contract. We have not established fair value for those future obligations; hence, generally accepted accounting principles in the United States, or GAAP, requires that we cannot begin to recognize any of the revenue or cost of sales derived from the sale of the CyberKnife system sold with our Platinum plan or the associated service plan until all upgrade obligations have been fulfilled. Therefore, the payments made by our customers who have our legacy Platinum plan are categorized as deferred revenue. Once we fulfill all upgrade obligations with respect to a specific Platinum plan, we ratably recognize the revenue and related cost of sales from the sale of that specific CyberKnife system and the Platinum plan over the remaining life of the contract.

 

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Table of Contents

 

Upgrades

 

Customers may purchase additional upgrades as optional extras prior to the delivery of all originally specified products and/or upgrade obligations. Such additional upgrades are considered elements of the original arrangement and associated revenues are deferred until the earlier of: (1) delivery of all elements, or (2) establishment of vendor specific objective evidence, or VSOE, of fair value for all undelivered elements. Sales of additional upgrades after delivery of all specified upgrade obligations, as stated in the original contract, are considered separate arrangements and are recognized once all revenue recognition criteria applicable to the separate arrangements are met.

 

Warranty

 

Customers purchasing a CyberKnife system typically receive up to a two year warranty included in the support agreement. In circumstances where we have VSOE of fair value for all undelivered elements, we recognize the CyberKnife system purchase price minus the fair value of support upon installation, and we recognize the value of one year of support ratably over the twelve months following installation.

 

Shared Ownership Program Revenue

 

We recognize revenue monthly from our shared ownership program that consists of a minimum monthly payment. We also recognize usage-based revenue in excess of the monthly minimum based on usage reports from our customers. We recognized revenue from our shared ownership program of $0.5 million and $1.4 million for the three and nine months ended March 31, 2010, respectively. We recognized revenue from our shared ownership program of $1.3 million and $3.2 million for the three and nine months ended March 31, 2009, respectively. The decrease in shared ownership revenue for the three and nine month period ended March 31, 2010 compared to the three and nine month period ended March 31, 2009 is due to the buyout of a large portion of the placement units throughout the previous fiscal year.  In limited cases, we received nonrefundable upfront payments from shared ownership program customers which are treated as deferred revenue and recognized over the term of the contract.

 

The CyberKnife system shared ownership systems are recorded within property and equipment and are depreciated over their estimated life of seven years. Depreciation and warranty expense attributable to shared ownership systems are recorded within cost of shared ownership program as they are incurred.

 

International Sales Revenue

 

We sell our products internationally through a combination of direct sales force and a network of distributors. We have strategically developed distributor relationships to serve our customers. Many of our distributors are responsible for installation and front-end support.

 

For international sales, we recognize revenue once we have met all of our obligations associated with the purchase agreement, other than for undelivered service elements for which we have VSOE of fair value. In situations where we are directly responsible for installation, we recognize revenue once we have installed the CyberKnife system and have confirmed performance against specification.  For sales through distributors, we recognize revenue after the distributor has shipped the unit to the end user or provided evidence of proof of sell-through to the end user, assuming all of our remaining obligations have been satisfied. Payments are sometimes secured through letters of credit.  Net revenue from international customers was $21.7 million and $53.7 million for the three and nine months ended March 31, 2010, respectively.  Net revenue from international customers was $12.2 million and $47.9 million for the three and nine months ended March 31, 2009, respectively.  We believe the increase in international sales for the three and nine months ended March 31, 2010 we believe is due to a number of factors, including the following: different impact of the economic downturn by country, greater significance of government affiliated hospital customers, and growth in select country markets.

 

Backlog

 

To be reported in our backlog, an order must have no contingencies as well as meet certain criteria, including a deposit from all customers other than governmental entities.  At March 31, 2010, our backlog included orders covering $125 million for systems, $18 million for shared ownership systems, and $207 million for service coverage.  It is our expectation that backlog will generally convert to revenue (through product shipments or provision of services) over approximately the following time periods: system orders over 1 year, shared ownership system orders over 2 to 5 years, and service over 1 to 5 years.

 

Although our backlog includes only contractual orders from our customers, we can not make assurances that we will convert it into recognized revenue due to factors outside our control, such as changes in customers’ needs or cancellation of orders.

 

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Table of Contents

 

Results of Operations

 

Overview

 

Our results of operations are divided into the following components:

 

Net revenue.  Our net revenue consists primarily of product revenue (revenue derived primarily from the sale of CyberKnife systems and the sale of linacs for other uses), shared ownership program revenue (revenue generated from our shared ownership program), services revenue (revenue generated from sales of post contract support service plans, installation and training) and other revenue (revenue from specialized upgrade services for units previously sold in Japan, other specialized services and other non-medical products).

 

Cost of revenue.  Cost of revenue consists primarily of material, labor and overhead costs. Cost of revenue may fluctuate from quarter to quarter depending on system configurations ordered by our customers and overall revenue mix.

 

Selling and marketing expenses.  Selling and marketing expenses consist primarily of costs for personnel and costs associated with participation in medical conferences, physician symposia, and advertising and promotional activities. We expect marketing expenses may fluctuate from quarter to quarter due to the timing of major marketing events, such as significant trade shows.

 

Research and development expenses.  Research and development expenses consist primarily of activities associated with our product development, regulatory and clinical study arrangements.

 

General and administrative expenses.  General and administrative expenses consist primarily of compensation and related costs for finance, in-house legal and human resources, and external expenses related to accounting, legal and other consulting fees.

 

Other income (expense), net.  Other income, net consists primarily of interest earned on our cash and cash equivalents and investments, unrealized gains on our trading securities, net of unrealized losses on our put option, foreign currency transaction gains and losses, losses on fixed asset disposals, and state and local sales and use tax fines and penalties. We expect our overall other income (expense) to decrease in the near future as we liquidate our auction rate securities and no longer record unrealized gains associated with these securities.  Interest income is not expected to change significantly in the near future.

 

Three and Nine Months Ended March 31, 2010 Compared to Three and Nine Months Ended March 31, 2009

 

Net Revenue

 

 

 

Three Months Ended
March 31,

 

Variance in

 

Variance in

 

Nine Months Ended
 March 31,

 

Variance in

 

Variance in

 

(Dollars in thousands)

 

2010

 

2009

 

Dollars

 

Percent

 

2010

 

2009

 

Dollars

 

Percent

 

Products

 

$

33,783

 

$

41,006

 

$

(7,223

)

(18

)%

$

99,815

 

$

119,762

 

$

(19,947

)

(17

)%

Shared ownership program

 

484

 

1,285

 

(801

)

(62

)%

1,421

 

3,197

 

(1,776

)

(56

)%

Services

 

17,545

 

17,901

 

(356

)

(2

)%

57,887

 

47,730

 

10,157

 

21

%

Other

 

128

 

1,109

 

(981

)

(88

)%

714

 

4,106

 

(3,392

)

(83

)%

Net Revenue

 

$

51,940

 

$

61,301

 

$

(9,361

)

(15

)%

$

159,837

 

$

174,795

 

$

(14,958

)

(9

)%

 

Total net revenue for the three months ended March 31, 2010 decreased $9.4 million from the three months ended March 31, 2009.  Excluding revenue recognized for systems sold under our Platinum plan, we recognized $31.7 million and $29.7 million of product revenue for the three months ended March 31, 2010 and 2009, respectively.  We recognized non-Platinum service revenue of $15.2 million for the three months ended March 31, 2010, which increased approximately $5.3 million from the three months ended March 31, 2009, due to the continued growth in our installed base under service plans. As of March 31, 2010 and 2009, 141 out of 153 and 96 out of 128 of our customers had purchased non-Platinum service plans.

 

We recognized $4.5 million of revenue for the three months ended March 31, 2010 from systems sold under our Platinum plan, consisting of $2.1 million for product revenue and $2.4 million for service revenue.  By comparison, we recognized $19.4 million of revenue for the three months ended March 31, 2009 from systems sold under our Platinum plan, including $11.3 million for product revenue and $8.0 million for service revenue. As of March 31, 2010, we had satisfied all upgrade delivery obligations on all units sold under our Platinum plan. Once all upgrade delivery obligations have been satisfied, revenue is recognized over the remaining term of the contract service term.

 

Total net revenue for the nine months ended March 31, 2010 decreased $15.0 million from the nine months ended March 31, 2009.  Excluding revenue recognized for systems sold under our Platinum plan, we recognized $88.9 million and $91.3 million of product revenue for the nine months ended March 31, 2010 and 2009, respectively.  We recognized non-Platinum service revenue of $44.9 million for the nine months ended March 31, 2010, which increased approximately $16.2 million from the nine months ended March 31, 2009, due to the continued growth in our installed base under service plans.

 

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Table of Contents

 

We recognized $23.9 million of revenue for the nine months ended March 31, 2010 from systems sold under our Platinum plan, $10.9 million for product revenue and $13.0 million for service revenue.  By comparison, we recognized $47.5 million of revenue for the nine months ended March 31, 2009 from systems sold under our Platinum plan, including $28.5 million for product revenue and $19.0 million for service revenue. As of March 31, 2010 we had satisfied all upgrade delivery obligations on all units sold under our Platinum plan. Once all upgrade delivery obligations have been satisfied, revenue is recognized over the remaining term of the contract service term.

 

We anticipate our non-Platinum revenue to continue to grow in future periods, while we expect Platinum revenue to decrease in future periods. Additionally, we expect our service revenue to increase as our installed base continues to grow.

 

Gross Profit

 

 

 

Three Months Ended March 31,

 

Nine Months Ended March 31,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(Dollars in
thousands)

 

(% of net
revenue)

 

(Dollars in
thousands)

 

(% of net
revenue)

 

(Dollars in
thousands)

 

(% of net
revenue)

 

(Dollars in
thousands)

 

(% of net
revenue)

 

Gross profit

 

$

25,376

 

48.9

%

$

30,362

 

49.5

%

$

72,960

 

45.6

%

$

88,200

 

50.5

%

Products

 

$

19,353

 

57.3

%

$

23,376

 

57.0

%

$

53,177

 

53.3

%

$

69,868

 

58.3

%

Shared ownership program

 

$

256

 

52.9

%

$

1,100

 

85.6

%

$

544

 

38.3

%

$

2,543

 

79.5

%

Services

 

$

5,739

 

32.7

%

$

5,844

 

32.6

%

$

19,028

 

32.9

%

$

15,516

 

32.5

%

Other

 

$

28

 

21.9

%

$

42

 

3.8

%

$

211

 

29.6

%

$

273

 

6.6

%

 

The gross profit margin was approximately the same in the three month periods ended March 31, 2010 and 2009.

 

The decrease in gross profit margin for the nine month period ended March 31, 2010 from the prior year was caused principally by two factors:

 

·                  Significant increase in service revenue as a percentage of total net revenue (service revenue generates a lower gross profit margin than product revenue), and

·                  Change in mix of direct and distributor sales, as well as a trend towards higher product functionality configurations which carry higher costs.

 

Selling and Marketing

 

 

 

Three Months Ended
March 31,

 

Variance in

 

Variance in

 

Nine Months Ended
March 31,

 

Variance in

 

Variance in

 

(Dollars in thousands)

 

2010

 

2009

 

Dollars

 

Percent

 

2010

 

2009

 

Dollars

 

Percent

 

Sales and marketing

 

$

7,179

 

$

11,420

 

$

(4,241

)

(37

)%

$

25,891

 

$

35,623

 

$

(9,732

)

(27

)%

Percentage of net revenue

 

13.8

%

18.6

%

 

 

 

 

16.2

%

20.4

%

 

 

 

 

 

Selling and marketing expenses for the three months ended March 31, 2010 decreased $4.2 million compared to the three months ended March 31, 2009. The decrease was primarily attributable to a $1.3 million decrease in compensation and benefits related expense and non-recurring employee separation costs of $0.5 million, both primarily due to the workforce alignment plan executed in fiscal year 2009, a decrease of $1.3 million due to lower advertising and trade show spending, a decrease in travel and related spending of $0.4 million as a result of lower headcount and reduced stock compensation charges of $0.6 million.

 

Selling and marketing expenses for the nine months ended March 31, 2010 decreased $9.7 million compared to the nine months ended March 31, 2009. The decrease was primarily attributable a $3.8 million decrease in compensation and benefits related expense and non-recurring employee separation costs of $0.4 million, primarily due to the workforce alignment plan executed in fiscal year 2009, a decrease of $2.6 million due to lower advertising and trade show spending, a decrease in travel and related spending of $1.1 million as a result of lower headcount, reduced stock compensation charges of $1.2 million and a $0.5 million decrease in spending for outside services.

 

Research and Development

 

 

 

Three Months Ended
March 31,

 

Variance in

 

Variance in

 

Nine Months Ended
March 31,

 

Variance in

 

Variance in

 

(Dollars in thousands)

 

2010

 

2009

 

Dollars

 

Percent

 

2010

 

2009

 

Dollars

 

Percent

 

Research and development

 

$

7,719

 

$

9,259

 

$

(1,540

)

(17

)%

$

23,150

 

$

26,807

 

$

(3,657

)

(14

)%

Percentage of net revenue

 

14.9

%

15.1

%

 

 

 

 

14.5

%

15.3

%

 

 

 

 

 

24



Table of Contents

 

Research and development expenses for the three months ended March 31, 2010 decreased $1.5 million compared to the three months ended March 31, 2009. The decrease was primarily attributable to lower compensation and benefits related expense of $0.7 million and non-recurring employee separation costs of $0.3 million, both partially due to the workforce alignment plan executed in fiscal year 2009, a decrease in spending for outside services of $0.2 million and reduced stock compensation charges of $0.2 million.

 

Research and development expenses for the nine months ended March 31, 2010 decreased $3.7 million compared to the nine months ended March 31, 2009. The decrease was primarily attributable to reduced compensation and benefits related expense of $2.2 million and non-recurring employee separation costs of $0.4 million, both partially due to the workforce alignment plan executed in fiscal year 2009, a reduction in spending on non-inventory materials due to fewer ongoing projects in the current year of $0.6 million and reduced stock compensation charges of $0.4 million.

 

We expect research and development discretionary spending to increase in the future as we begin new development projects.

 

General and Administrative

 

 

 

Three Months Ended
March 31,

 

Variance in

 

Variance in

 

Nine Months Ended
March 31,

 

Variance in

 

Variance in

 

(Dollars in thousands)

 

2010

 

2009

 

Dollars

 

Percent

 

2010

 

2009

 

Dollars

 

Percent

 

General and administrative

 

$

7,719

 

$

8,821

 

$

(1,102

)

(12

)%

$

27,079

 

$

28,513

 

$

(1,434

)

(5

)%

Percentage of net revenue

 

14.9

%

14.4

%

 

 

 

 

16.9

%

16.3

%

 

 

 

 

 

General and administrative expenses for the three months ended March 31, 2010 decreased $1.1 million compared to the three months ended March 31, 2009.  The decrease was primarily attributable to reduced compensation and benefits related expense of $0.6 million and non-recurring employee separation costs of $0.4 million, both partially due to the workforce alignment plan executed in fiscal year 2009, a reduction in stock compensation charges of $0.4 million, partially offset by an increase in other outside services of $0.5 million associated with accounting and tax services performed and increased legal fees principally associated with the ongoing class action shareholder lawsuit.

 

General and administrative expenses for the nine months ended March 31, 2010 decreased $1.4 million compared to the nine months ended March 31, 2009. The decrease was primarily attributable to a $1.6 million reduction in non-recurring employee separation costs in the nine months ended March 31, 2009, and lower compensation and benefits related expense of $1.4 million, both primarily due to the workforce alignment plan executed in fiscal year 2009, a decrease in stock-based compensation of $1.3 million and a decrease of $0.4 million of facilities expenses.  The decrease in general and administrative expense was partially offset by an increase of $3.6 million in other outside services primarily associated with increased legal fees principally associated with the ongoing class action shareholder lawsuit and accounting and tax services performed.

 

Other Income, Net

 

 

 

Three Months Ended
March 31,

 

Variance in

 

Variance in

 

Nine Months Ended
March 31,

 

Variance in

 

Variance in

 

(Dollars in thousands)

 

2010

 

2009

 

Dollars

 

Percent

 

2010

 

2009

 

Dollars

 

Percent

 

Other income, net

 

$

(227

)

$

575

 

$

(802

)

(139

)%

$

684

 

$

2,436

 

$

(1,752

)

(72

)%

Percentage of net revenue

 

-0.4

%

0.9

%

 

 

 

 

0.4

%

1.4

%

 

 

 

 

 

Other income (loss), net decreased $0.8 million to an “other loss” position for the three months ended March 31, 2010 compared to the three months ended March 31, 2009.  The decrease was primarily attributable to a decrease in interest income of about $0.7 million due to lower average interest rates earned on amounts kept in interest bearing accounts during the three months ended March 31, 2010, compared to the three months ended March 31, 2009, plus an increase of $0.1 million related to foreign currency transaction losses.

 

Other income, net decreased $1.8 million for the nine months ended March 31, 2010 compared to the nine months ended March 31, 2009.  The decrease was attributable to a $1.7 million decrease in interest income due to lower average interest rates earned on amounts kept in interest bearing accounts during the nine months ended March 31, 2010, compared to the nine months ended March 31, 2009, and a $1.2 million decrease in foreign currency transaction gains.  These decreases were partially offset by an increase in the realized gain on the sale of investment of $1.0 million as we recorded a net $0.9 million loss on our auction rate securities in the nine month period ended March 31, 2009 relating the reclassification of these securities from available-for-sale to trading securities.

 

25


 


Table of Contents

 

Provision for (Benefit from) Incomes Taxes

 

 

 

Three Months Ended

 

 

 

 

 

Nine Months Ended

 

 

 

 

 

 

 

March 31,

 

Variance in

 

Variance in

 

March 31,

 

Variance in

 

Variance in

 

(Dollars in thousands)

 

2010

 

2009

 

Dollars

 

Percent

 

2010

 

2009

 

Dollars

 

Percent

 

Provision for (benefit from) income taxes

 

$

260

 

$

221

 

$

39

 

18

%

$

(297

)

$

306

 

$

(603

)

(197

)%

Percentage of net revenue

 

0.5

%

0.4

%

 

 

 

 

-0.2

%

0.2

%

 

 

 

 

 

On a quarterly basis, we provide for income taxes based upon an estimated annual effective income tax rate.  This process involves estimating actual current tax expense together with assessing temporary differences in the treatment of items for tax purposes versus financial accounting purposes that may create net deferred tax assets and liabilities.

 

For the three months ended March 31, 2010 and 2009, the Company recorded income tax expense of $0.3 million and $0.2 million, respectively.  The increase in tax of $0.1 million is primarily related to an increase in corporate earnings of foreign subsidiaries.

 

Benefit from income taxes was $0.3 million, or 12.0% of pre-tax loss for the nine months ended March 31, 2010, compared to income tax of $0.3 million, or 99.7% of pre-tax loss for the nine months ended March 31, 2009. The tax benefit of $0.3 million represents the net of income taxes primarily on corporate earnings of foreign subsidiaries offset by an alternative minimum tax benefit realized from the carryback of fiscal year 2009 alternative minimum tax losses to earlier years net of foreign taxes resulting from corporate earnings of foreign subsidiaries.  A federal law change enacted in November 2009 allows an elective increased carryback period for NOLs incurred in tax years ending after December 31, 2007 and beginning before January 1, 2010, including the ability to fully offset alternative minimum taxable income with those losses.  The impact of the anticipated carryback and carryforward of fiscal year 2009 alternative minimum tax losses resulted in a tax benefit of $0.9 million been recorded during the three months ended December 31, 2009.

 

Stock-Based Compensation Expense

 

Stock-based compensation expense was recorded net of estimated forfeitures for the three and nine months ended March 31, 2010 and 2009 such that expense was recorded only for those stock-based awards that are expected to vest. For the three months ended March 31, 2010 and 2009, we recorded $1.9 million and $3.1 million, respectively, of stock-based compensation expense, net of estimated forfeitures, for stock options, 2007 Employee Stock Purchase Plan, or ESPP, shares issued and RSUs granted to employees. During the three months ended March 31, 2010 we revised our estimate of the rate of forfeitures to better reflect actual forfeitures which have been higher than we originally estimated. This resulted in a $0.8 million reduction in overall stock-based compensation expense in the quarter. For the nine months ended March 31, 2010 and 2009, we recorded $8.2 million and $11.7 million, respectively, of comparable stock-based compensation expense. During the three and nine months ended March 31, 2009, we recognized $32,000 and $0.9 million, respectively, of stock-based compensation expense related to accelerated vesting of stock options and RSUs in conjunction with non-recurring employee separation costs, included in the total compensation amounts above. No such expense was recognized for the three or nine months ended March 31, 2010.

 

Liquidity and Capital Resources

 

At March 31, 2010, we had $145.8 million in cash, cash equivalents and marketable securities. In November 2008, we obtained a line of credit with UBS, which is due on demand and allows for borrowings of up to 75% of par value of ARS. No borrowings were outstanding as of March 31, 2010. We believe that we have sufficient cash resources and anticipated cash flows to continue in operation for at least the next 12 months.

 

Cash Flows From Operating Activities

 

Net cash used in operating activities was $12.9 million for the nine months ended March 31, 2010. Our net loss of $2.2 million contributed to the use of cash. Negative cash flow from working capital changes include a decrease in deferred revenue, net of deferred cost of revenue of $15.8 million, a $5.5 million decrease in accounts payable, a $5.5 million increase in prepaid expenses and other assets and an increase in inventory of $0.6 million, partially offset by a $1.5 million increase in accrued liabilities, a $0.7 million decrease in accounts receivable and an increase of $0.3 million in inventory reserves. The decrease in deferred revenue, net of deferred cost of revenue, was primarily a result of the recognition of revenue previously deferred for systems sold under our Platinum plan, offset partially by differences between invoicing customers for products and services and the recognition of the invoicing as revenue. The decrease in accounts payable was primarily due to a reduction in our operating expenses.  Non-cash charges included $8.2 million of stock-based compensation and $5.6 million of depreciation and amortization expense.

 

26



Table of Contents

 

Cash Flows From Investing Activities

 

Net cash provided by investing activities was $10.0 million for the nine months ended March 31, 2010, which was primarily attributable to net marketable security activities of $12.0 million, which consisted of $86.3 million of sales and maturities of marketable securities, offset by $74.3 million in purchases. We also used $2.5 million of cash for purchases of property and equipment. Our restricted cash decreased by $0.4 million due to decreased amounts related to contracts with customers requiring that deposited cash amounts be secured via letter of credit until delivery of the CyberKnife unit occurs.

 

Cash Flows From Financing Activities

 

Net cash provided by financing activities for the nine months ended March 31, 2010 was $1.9 million, which was attributable to proceeds from the exercise of common stock options and the purchase of common stock under our employee stock plans, offset by excess tax benefit from stock-based compensation of $0.5 million.

 

Operating Capital and Capital Expenditure Requirements

 

Our future capital requirements depend on numerous factors. These factors include but are not limited to the following:

 

· revenue generated by sales of the CyberKnife system, our shared ownership program and service plans;

· costs associated with our sales and marketing initiatives and manufacturing activities;

· rate of progress and cost of our research and development activities;

· costs of obtaining and maintaining FDA and other regulatory clearances of the CyberKnife system;

· number and timing of acquisitions and other strategic transactions.

 

We believe that our current cash and cash equivalents will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for the next twelve months. If these sources of cash and cash equivalents are insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or debt securities or obtain additional credit facilities. The sale of additional equity or convertible debt securities could result in dilution to our stockholders. If additional funds are raised through the issuance of debt securities, these securities could have rights senior to those associated with our common stock and could contain covenants that would restrict our operations. Additional financin