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, 2011
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 |
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20-8370041 |
(State or Other Jurisdiction of Incorporation or Organization) |
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(IRS Employer Identification Number) |
1310 Chesapeake Terrace
Sunnyvale, California 94089
(Address of Principal Executive Offices Including Zip Code)
(408) 716-4600
(Registrants 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 |
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Accelerated filer x |
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Non-accelerated filer o |
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Smaller reporting company o |
(Do not check if a smaller reporting company) |
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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, 2011, there were 60,155,187 shares of the Registrants Common Stock, par value $0.001 per share, outstanding.
Accuray Incorporated
Form 10-Q for the Quarter Ended March 31, 2011
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Managements Discussion and Analysis of Financial Condition and Results of Operations |
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32 | ||
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Item 1. Condensed Consolidated Financial Statements
Accuray Incorporated
Condensed Consolidated Balance Sheets
(in thousands, except share and per share amounts)
(unaudited)
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March 31, |
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June 30, |
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2011 |
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2010 |
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Assets |
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Current assets: |
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Cash and cash equivalents |
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$ |
57,332 |
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$ |
45,434 |
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Restricted cash |
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22 |
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22 |
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Short-term available-for-sale securities |
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85,603 |
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99,881 |
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Accounts receivable, net of allowance for doubtful accounts of $225 and $115 at March 31, 2011 and June 30, 2010, respectively |
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44,871 |
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37,955 |
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Inventories |
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34,408 |
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28,186 |
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Prepaid expenses and other current assets |
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9,150 |
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19,356 |
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Deferred cost of revenuecurrent |
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5,131 |
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7,889 |
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Total current assets |
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236,517 |
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238,723 |
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Deferred cost of revenuenoncurrent |
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2,193 |
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3,213 |
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Property and equipment, net |
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16,514 |
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14,684 |
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Goodwill |
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4,495 |
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4,495 |
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Intangible assets, net |
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194 |
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388 |
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Other assets |
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1,816 |
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1,681 |
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Total assets |
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$ |
261,729 |
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$ |
263,184 |
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Liabilities and stockholders equity |
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Current liabilities: |
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Accounts payable |
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$ |
9,873 |
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$ |
10,317 |
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Accrued compensation |
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9,941 |
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10,786 |
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Other accrued liabilities |
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7,881 |
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10,669 |
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Customer advances |
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13,484 |
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12,884 |
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Deferred revenuecurrent |
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35,626 |
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42,019 |
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Total current liabilities |
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76,805 |
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86,675 |
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Long-term liabilities: |
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Long-term other liabilities |
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999 |
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1,059 |
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Deferred revenuenoncurrent |
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4,655 |
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5,374 |
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Total liabilities |
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82,459 |
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93,108 |
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Commitments and contingencies (Note 7) |
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Stockholders equity: |
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Preferred stock, $0.001 par value; authorized: 5,000,000 shares; no shares issued and outstanding |
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Common stock, $0.001 par value; authorized: 100,000,000 shares; issued: 62,291,644 and 60,666,974 shares at March 31, 2011 and June 30, 2010, respectively; outstanding: 60,151,626 and 58,526,956 shares at March 31, 2011 and June 30, 2010, respectively |
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60 |
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59 |
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Additional paid-in capital |
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298,530 |
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287,764 |
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Accumulated other comprehensive income (loss) |
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85 |
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(71 |
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Accumulated deficit |
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(119,405 |
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(117,676 |
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Total stockholders equity |
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179,270 |
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170,076 |
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Total liabilities and stockholders equity |
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$ |
261,729 |
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$ |
263,184 |
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Condensed consolidated balance sheet at June 30, 2010 has been derived from audited consolidated financial statements.
The accompanying notes are an integral part of these condensed consolidated financial statements.
Accuray Incorporated
Condensed Consolidated Statements of Operations
(in thousands, except per share amounts)
(unaudited)
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Three Months Ended |
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Nine Months Ended |
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March 31, |
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March 31, |
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2011 |
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2010 |
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2011 |
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2010 |
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Net revenue: |
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Products |
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$ |
35,249 |
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$ |
33,783 |
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$ |
88,915 |
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$ |
99,815 |
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Shared ownership programs |
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335 |
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484 |
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1,856 |
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1,421 |
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Services |
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18,253 |
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17,545 |
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54,833 |
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57,887 |
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Other |
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910 |
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128 |
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1,457 |
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714 |
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Total net revenue |
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54,747 |
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51,940 |
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147,061 |
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159,837 |
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Cost of revenue: |
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Cost of products |
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14,114 |
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14,430 |
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34,508 |
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46,638 |
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Cost of shared ownership programs |
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85 |
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228 |
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379 |
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877 |
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Cost of services |
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12,152 |
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11,806 |
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35,397 |
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38,859 |
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Cost of other |
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1,083 |
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100 |
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1,761 |
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503 |
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Total cost of revenue |
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27,434 |
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26,564 |
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72,045 |
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86,877 |
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Gross profit |
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27,313 |
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25,376 |
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75,016 |
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72,960 |
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Operating expenses: |
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Selling and marketing |
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8,127 |
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7,179 |
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23,874 |
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25,891 |
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Research and development |
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9,291 |
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7,719 |
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26,651 |
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23,150 |
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General and administrative |
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10,421 |
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7,719 |
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27,461 |
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27,079 |
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Total operating expenses |
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27,839 |
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22,617 |
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77,986 |
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76,120 |
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Income (loss) from operations |
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(526 |
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2,759 |
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(2,970 |
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(3,160 |
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Other income (loss), net |
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22 |
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(227 |
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2,314 |
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684 |
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Income (loss) before provision for (benefit from) income taxes |
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(504 |
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2,532 |
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(656 |
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(2,476 |
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Provision for (benefit from) income taxes |
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656 |
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260 |
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1,046 |
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(297 |
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Net income (loss) |
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$ |
(1,160 |
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$ |
2,272 |
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$ |
(1,702 |
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$ |
(2,179 |
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Net income (loss) per share: |
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Basic net income (loss) per share |
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$ |
(0.02 |
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$ |
0.04 |
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$ |
(0.03 |
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$ |
(0.04 |
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Weighted average common shares used in computing basic net income (loss) per share |
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59,960 |
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57,851 |
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59,298 |
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57,352 |
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Diluted net income (loss) per share |
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$ |
(0.02 |
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$ |
0.04 |
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$ |
(0.03 |
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$ |
(0.04 |
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Weighted average common shares used in computing diluted net income (loss) per share |
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59,960 |
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60,470 |
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59,298 |
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57,352 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
Accuray Incorporated
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
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Nine Months Ended March 31, |
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2011 |
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2010 |
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Cash Flows From Operating Activities |
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Net loss |
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$ |
(1,702 |
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$ |
(2,179 |
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Adjustments to reconcile net loss to net cash used in operating activities: |
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Depreciation and amortization |
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4,446 |
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5,564 |
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Stock-based compensation |
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6,395 |
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8,237 |
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Realized gain on investments |
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(3 |
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(2 |
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Unrealized loss on long-term trading securities, net of gain on put option |
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(251 |
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Provision for (recovery of) bad debts |
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111 |
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(460 |
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Loss on write-down of inventories |
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687 |
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271 |
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Loss (gain) on disposal of property and equipment |
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(22 |
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27 |
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Restricted cash |
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439 |
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Changes in assets and liabilities: |
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Accounts receivable |
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(6,156 |
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727 |
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Inventories |
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(7,826 |
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586 |
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Prepaid expenses and other current assets |
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867 |
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(5,484 |
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Deferred cost of revenue |
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5,503 |
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5,176 |
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Other assets |
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(102 |
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(162 |
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Accounts payable |
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(2,950 |
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(5,494 |
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Accrued liabilities |
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(531 |
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1,521 |
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Customer advances |
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(22 |
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44 |
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Deferred revenue |
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(7,787 |
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(20,990 |
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Net cash used in operating activities |
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(9,092 |
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(12,430 |
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Cash Flows From Investing Activities |
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Purchases of property and equipment |
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(4,061 |
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(2,529 |
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Purchase of investments |
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(100,710 |
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(74,302 |
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Sale and maturity of investments |
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120,820 |
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86,347 |
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Net cash provided by investing activities |
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16,049 |
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9,516 |
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Cash Flows From Financing Activities |
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Proceeds from issuance of common stock |
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3,281 |
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1,499 |
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Proceeds from employee stock purchase plan |
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973 |
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872 |
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Excess tax benefit from stock-based compensation |
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(498 |
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Net cash provided by financing activities |
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4,254 |
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1,873 |
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Effect of exchange rate changes on cash |
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687 |
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242 |
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Net increase (decrease) in cash and cash equivalents |
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11,898 |
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(799 |
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Cash and cash equivalents at beginning of period |
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45,434 |
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36,835 |
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Cash and cash equivalents at end of period |
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$ |
57,332 |
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$ |
36,036 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
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. Physicians determine when and how the CyberKnife system should be used in the treatment of patients. The CyberKnife system is designed to treat small to medium sized, discrete tumors, and is generally not used to treat (1) very large tumors, which are considerably wider than the radiation beam that can be delivered by the CyberKnife system, (2) diffuse, wide-spread disease, as is often the case for late stage cancers, because they are not localized (though the CyberKnife system might be used to treat a focal area of the disease) and (3) systemic disease, like leukemias and lymphomas, which are not localized to an organ, but rather involve cells throughout the body.
The Company is incorporated in Delaware, USA and has fourteen 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, SAR, 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, Accuray Tibbi Cihazlar Ve Malzemeler Ithalat Ihracat Anonim Sirketi, located in Istanbul, Turkey, Accuray Mexico SA de CV located in Mexico City, Mexico, Accuray Medical Equipment Canada Ltd. located in Vancouver, Canada and Jaguar Acquisition, Inc., a Wisconsin corporation. Jaguar Acquisition, Inc. was formed solely for the purpose of entering into the Merger Agreement described in Note 10 below. The purpose of the other subsidiaries is to market and/or service the Companys products in the various countries in which they are located.
2. Summary of Significant Accounting Policies
Basis of Presentation and Principles of Consolidation
The condensed consolidated financial statements for the fiscal year ended June 30, 2010 include the accounts of the Company and its subsidiaries and the Companys variable interest entity, Morphormics, Inc. (Morphormics). As the Company is no longer considered the primary beneficiary of Morphormics, the condensed consolidated financial statements for periods in fiscal year 2011 do not include Morphormics. Refer to Note 6. Investment. All significant inter-company transactions and balances have been eliminated in consolidation.
The accompanying condensed consolidated balance sheet as of March 31, 2011 and the condensed consolidated statements of operations for the three and nine-month periods ended March 31, 2011 and 2010 and the condensed consolidated statements of cash flows for the nine-month periods ended March 31, 2011 and 2010 and other information disclosed in the related notes are unaudited. The condensed consolidated balance sheet as of June 30, 2010 was derived from the Companys 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 Companys Annual Report on Form 10-K for the year ended June 30, 2010 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, 2011 are not necessarily indicative of the results to be expected for the year ending June 30, 2011 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.
Foreign Currency
The Companys 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 the average exchange rate. Resulting translation adjustments are excluded from the determination of net income and are recorded in accumulated other comprehensive income (loss) as a separate component of stockholders equity. Net foreign currency exchange transaction gains or losses are included as a component of other income (loss), net, in the Companys condensed consolidated statements of operations for the three and nine months ended March 31, 2011.
The majority of the Companys executed sales contracts are denominated in U.S. dollars. The CyberKnife system sales contracts denominated in foreign currency are direct end customer transactions for international customers.
Cash and Cash Equivalents
The Company considers all highly liquid investments with 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 has historically included 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 unit occurs. At March 31, 2011 and June 30, 2010, restricted cash balance represents funds held to guarantee funding of certain foreign taxes.
Fair Value of Financial Instruments
The carrying values of the Companys financial instruments including cash and cash equivalents, marketable securities, restricted cash, accounts receivable and accounts payable are approximately equal to their respective fair values due to the relatively short-term nature of these instruments.
Marketable Securities
The Companys 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 (loss). 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 maturities greater than approximately three months on the date of purchase and remaining maturities of one year or less are classified as short-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.
Interest, dividends, amortization and accretion of purchase premiums and discounts on all of the Companys 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 Companys ability to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value.
Concentration of Credit Risk
The Companys cash and cash equivalents are mainly deposited with two major financial institutions and generally exceed the amount of insurance provided on such deposits. The Company has not experienced any losses in such accounts and believes that it is not exposed to any significant risk on these balances.
For the three months ended March 31, 2011, there was one customer that represented 14% of total net revenue. For the nine months ended March 31, 2011 and 2010, and the three months ended March 31, 2010, there were no customers that represented 10% or more of total net revenue. The Company had one customer who constituted 18% of the Companys net accounts receivable at March 31, 2011. No customer accounted for 10% or more at June 30, 2010.
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 managements 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 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), training and other professional services. 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 revenue arrangements with multiple elements which were entered into by June 30, 2010 and which have not subsequently been materially modified, 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 Companys standard rates charged for the product or service when such product or service is sold separately or based upon the price established by the Companys pricing committee 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, and (2) establishment of VSOE of fair value for all remaining undelivered elements.
In the first quarter of fiscal 2011, the Company adopted Accounting Standards Update (ASU) 2009-13, Multiple-Deliverable Revenue Arrangements, (amendments to Accounting Standards Codification (ASC) Topic 605, Revenue Recognition) (ASU 2009-13) (formerly Emerging Issues Task Force (EITF) Issue 08-1) and ASU 2009-14, Certain Arrangements That Include Software Elements, (amendments to Financial Accounting Standards Board (FASB) ASC Topic 985, Software) (ASU 2009-14) (formerly EITF 09-3). The new standard changes the requirements for establishing separate units of accounting in a multiple element arrangement and requires the allocation of arrangement consideration to each deliverable to be based on the relative selling price. The FASB also amended the accounting standards for revenue recognition to exclude software that is contained in a tangible product from the scope of software revenue guidance if the software is essential to the tangible products functionality. The Company adopted these new standards on a prospective basis; therefore, they apply only to revenue arrangements entered into or materially modified beginning July 1, 2010. For revenue arrangements that were entered into or materially modified after the adoption of these standards, implementation of this new authoritative guidance had an insignificant impact on the Companys reported net revenue since the first quarter of fiscal 2011 as compared to net revenue if the related arrangements entered into or modified after the effective date were subject to the accounting requirements in effect in the prior year.
Under the new accounting guidance, in evaluating the revenue recognition for agreements which contain multiple deliverables, the Company determined that in certain instances it was not able to establish VSOE for all deliverables in an arrangement as the Company infrequently sells each element on a stand-alone basis, does not price products within a narrow range, or has a limited sales history. When VSOE cannot be established, the Company attempts to establish the selling price of each element based on relevant third-party evidence (TPE). TPE is determined based on competitors prices for similar deliverables when sold separately. Generally, the Companys offerings contain a significant level of proprietary technology, customization or differentiation such that the comparable pricing of products with similar functionality cannot be obtained. Furthermore, the Company is unable to reliably determine what similar competitors products selling prices are on a stand-alone basis. Therefore, the Company typically is not able to determine TPE.
When the Company is unable to establish selling price using VSOE or TPE, the Company uses its best estimate of selling price (BESP) in the Companys allocation of arrangement consideration. The objective of BESP is to determine the price at which the Company would transact a sale if the product or service were sold on a stand-alone basis. BESP is generally used for offerings that are not typically sold on a stand-alone basis or for new or highly customized offerings. The Company determines BESP for a product or service by considering multiple factors including, but not limited to, pricing practices, internal costs, geographies and gross margin. The determination of BESP is made through consultation with and formal approval by the Companys pricing committee, taking into consideration the overall go-to-market pricing strategy.
As the Companys go-to-market strategies and other factors evolve, the Company may modify its pricing practices in the future, which could result in changes in selling prices, including VSOE, TPE and BESP. As a result, the Companys future revenue recognition for multiple element arrangements could differ materially from that recorded in the current period. The Company regularly reviews VSOE, TPE and BESP and maintains internal controls over the establishment and update of these inputs.
The Company has a limited number of software offerings which are not required to deliver the tangible products essential functionality and can be sold separately. Revenues from sales of these software products and related post-contract support will continue to be accounted for under software revenue recognition rules. The Companys multiple-element arrangements may therefore have a software deliverable that is subject to the existing software revenue recognition guidance. The revenue for these multiple-element arrangements is allocated to the software deliverable or group of software deliverables and the non-software deliverables based on the relative selling prices of all of the deliverables in the arrangement using the hierarchy in the new revenue recognition accounting guidance.
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.
The Companys agreements with customers and distributors generally do not contain product return rights.
CyberKnife system sales with legacy service plans
For sales of CyberKnife systems with PCS arrangements entered into prior to the first quarter of fiscal 2011 and not materially modified after the adoption of ASU 2009-13 and ASU 2009-14 that included rights to specified or committed upgrades for which the Company had not established VSOE of fair value, all revenue and cost of revenue related to the CyberKnife systems and subsequent PCS was deferred. Once all such upgrade obligations had been delivered, all accumulated and deferred revenue and cost of revenue for the CyberKnife systems and related PCS began to be 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 were considered additional elements of the original arrangement and associated revenues were deferred and accounted for as described above. Sales of additional upgrades after delivery of all specified upgrade obligations, as stated in the original contract, were recognized once all revenue recognition criteria applicable to those arrangements were met.
CyberKnife system sales with nonlegacy service plans
Currently, the Company sells CyberKnife systems with PCS contracts that 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 entered into or materially modified after June 30, 2010, with multiple elements that include the CyberKnife system, installation services, training services and a PCS service agreement, the Company recognizes revenue for the CyberKnife system and installation services, if applicable, by application of the relative selling price method for all elements in the arrangement, including PCS. If the Company is responsible for installation, the Company recognizes revenue only after installation and acceptance of the system. Otherwise, revenue is recognized upon delivery.
Other revenue
Other revenue primarily consists of research and development and construction contract revenues.
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 obligations 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 system upgrades 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 quotations 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.
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 customers 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 and minimum monthly payments from the customer are recognized as revenue over the contractual period. Additional revenues beyond the minimum payments 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. The Company recognized $0.3 million and $1.9 million for the three and nine months ended March 31, 2011, respectively, of revenue from the shared ownership program. The Company recognized $0.5 million and $1.4 million for the three and nine months ended March 31, 2010, respectively, of revenue from the shared ownership program.
Future minimum revenues under shared ownership arrangements as of March 31, 2011 are as follows (in thousands):
2011 (remaining three months) |
|
$ |
199 |
|
2012 |
|
794 |
| |
2013 |
|
734 |
| |
2014 |
|
554 |
| |
2015 |
|
693 |
| |
Total |
|
$ |
2,974 |
|
Total usage-based fee revenues, which are included in shared ownership program revenue, earned from the CyberKnife systems under the shared ownership program amounted to $0.1 million and $0.2 million for the three and nine months ended March 31, 2011, respectively.
Under the terms of the shared ownership program, the customer has the option to purchase the CyberKnife system at predetermined 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 Companys revenue recognition policy, taking into account the PCS and any other elements that might be sold as part of the arrangement. There were no sales conversions of the Companys shared ownership system during the three months ended March 31, 2011. Product revenue of $3.6 million was recognized during the nine months ended March 31, 2011 from the sale of one CyberKnife system that was formerly a part of the Companys shared ownership program.
The CyberKnife systems associated with the Companys shared ownership program are recorded within property and equipment. Depreciation and warranty expenses attributable to the CyberKnife shared ownership systems are recorded within cost of shared ownership programs.
Long-term construction and manufacturing contracts
The Company recognizes revenue and cost of revenue related to long-term construction and manufacturing contracts using contract accounting on the percentage-of-completion or the completed contract method. The Company 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 Companys 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 typically results from the 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 or upgrade products, service upgrade costs for which the revenue has been deferred in accordance with the Companys revenue recognition policy, and deferred costs associated with research and development contract costs. 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 Purchased Intangible Assets
Goodwill and purchased 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 purchased intangible assets resulted from the Companys 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, 2011, there were no indicators of impairment.
Stock-Based Compensation
The Company accounts for stock-based compensation by measuring and recognizing the fair value of all stock-based payment awards made to employees based on the estimated grant date fair values, including employee stock options, restricted stock awards and the employee stock based purchase plan. The Company uses the Black-Scholes option pricing model to estimate the value of employee stock options which requires a number of significant estimates to determine the model inputs. These include the expected volatility of the stocks market price, the expected term of the stock-based awards, the expected risk free rate of interest and any dividend yields. As stock-based compensation expense is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. The Company estimates and adjusts forfeiture rates based on a periodic review of recent forfeiture activity and expected future employee turnover. As the Company has been operating as a public company for a period of time that is shorter than its estimated expected option life, the Company concluded that its historical price volatility does not provide a reasonable basis for input assumptions within its Black-Scholes valuation model when determining the fair value of its stock options. As a result, expected volatility is based on the historical volatility of a peer group of publicly traded companies. The Company continues to use the simplified method for the estimated term of the awards.
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 Companys 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 carryforwards and temporary differences.
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 Companys 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 Share
Basic net income (loss) per share is calculated based on the weighted-average number of shares of the Companys common stock outstanding during the period. Common stock equivalent shares, which are based on the number of shares underlying outstanding stock options and, restricted stock units, or RSUs, are included in the calculation of diluted net income per share unless the effect of their inclusion would be anti-dilutive. For the three months ended March 31, 2011 and 2010, 4,902,833 and 3,984,761 of anti-dilutive weighted shares, respectively, were excluded from the calculation of common stock equivalent shares. For the nine months ended March 31, 2011 and 2010, 5,964,412 and 4,168,715 of anti-dilutive weighted shares, respectively, were excluded from the calculation of common stock equivalent shares.
The following table sets forth the basic and diluted per share computations:
|
|
Three Months Ended |
|
Nine Months Ended |
| ||||||||
|
|
March 31, |
|
March 31, |
| ||||||||
(In thousands, except per share data) |
|
2011 |
|
2010 |
|
2011 |
|
2010 |
| ||||
Numerator: |
|
|
|
|
|
|
|
|
| ||||
Net income (loss) |
|
$ |
(1,160 |
) |
$ |
2,272 |
|
$ |
(1,702 |
) |
$ |
(2,179 |
) |
Denominator: |
|
|
|
|
|
|
|
|
| ||||
Basic weighted-average shares outstanding |
|
59,960 |
|
57,851 |
|
59,298 |
|
57,352 |
| ||||
Stock options and restricted stock units |
|
|
|
2,619 |
|
|
|
|
| ||||
Diluted weighted-average shares of common stock and equivalent outstanding |
|
59,960 |
|
60,470 |
|
59,298 |
|
57,352 |
| ||||
Basic net income (loss) per share: |
|
$ |
(0.02 |
) |
$ |
0.04 |
|
$ |
(0.03 |
) |
$ |
(0.04 |
) |
Diluted net income (loss) per share: |
|
$ |
(0.02 |
) |
$ |
0.04 |
|
$ |
(0.03 |
) |
$ |
(0.04 |
) |
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, 2011 and 2010 is as follows (in thousands):
|
|
Three Months Ended |
|
Nine Months Ended |
| ||||||||
|
|
March 31, |
|
March 31, |
| ||||||||
|
|
2011 |
|
2010 |
|
2011 |
|
2010 |
| ||||
Net income (loss) |
|
$ |
(1,160 |
) |
$ |
2,272 |
|
$ |
(1,702 |
) |
$ |
(2,179 |
) |
Unrealized loss on investments |
|
(25 |
) |
(186 |
) |
(23 |
) |
(333 |
) | ||||
Foreign currency translation |
|
135 |
|
(22 |
) |
179 |
|
(21 |
) | ||||
Comprehensive income (loss) |
|
$ |
(1,050 |
) |
$ |
2,064 |
|
$ |
(1,546 |
) |
$ |
(2,533 |
) |
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 Companys long-lived assets maintained outside the United States are not material.
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 Companys customers. The following summarizes revenue by geographic region (in thousands):
|
|
Three Months Ended |
|
Nine Months Ended |
| ||||||||
|
|
March 31, |
|
March 31, |
| ||||||||
|
|
2011 |
|
2010 |
|
2011 |
|
2010 |
| ||||
Americas (including Puerto Rico) |
|
$ |
28,010 |
|
$ |
30,243 |
|
$ |
89,971 |
|
$ |
106,116 |
|
Europe |
|
18,395 |
|
17,161 |
|
38,920 |
|
42,097 |
| ||||
Asia (excluding Japan) |
|
3,485 |
|
3,280 |
|
10,506 |
|
5,026 |
| ||||
Japan |
|
4,857 |
|
1,256 |
|
7,664 |
|
6,598 |
| ||||
Total |
|
$ |
54,747 |
|
$ |
51,940 |
|
$ |
147,061 |
|
$ |
159,837 |
|
Recent Accounting Pronouncement
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. The new disclosures and clarifications under this ASU are effective over a period of two fiscal years, for interim and annual reporting periods beginning after December 15, 2009 and for annual reporting periods after December 15, 2010. The first adoption date updates under ASU No. 2010-06 did not have a material impact on the Companys consolidated financial statements. The adoption of the second date of updates is not expected to have a material impact on the Companys consolidated financial statements.
3. Collaboration Agreement
In June 2010, the Company entered into a Strategic Alliance Agreement, or the Alliance Agreement, with Siemens AG, or Siemens, pursuant to which (1) the Company agreed to grant Siemens certain distribution rights to CyberKnife systems, (2) Siemens agreed to incorporate certain technology of the Company into certain of its linear accelerator products, the combined products being known as the Cayman Products, and (3) a research and development relationship was created between the Company and Siemens for the pursuit and implementation of other potential collaboration opportunities in the future.
The Alliance Agreement provides that Accuray will grant Siemens distribution rights to the CyberKnife system, allowing Siemens to include the CyberKnife system in multi-product sales when it also sells its own linear accelerator products or imaging products. The Company and Siemens entered into a Multiple Linac and Multi-Modality Distribution Agreement, or Distribution Agreement, which sets forth the terms of these distribution rights. Each sale under the Distribution Agreement is subject to pre-approval by the Company. The Alliance Agreement also provides that Siemens and the Company will negotiate in good faith separate distribution agreements for the distribution by Siemens of the CyberKnife system in certain countries and regions throughout the world not currently able to be fully served by the Company.
The Alliance Agreement also provides that Siemens will pay the Company a fee to develop certain technology. Siemens will have the exclusive right to purchase from the Company products incorporating this technology solely for use in Cayman Products, but the Company may terminate Siemens exclusivity if Siemens fails to meet certain specified sales targets, or if the initial shipment of a Cayman Product does not occur within a specified period of time. The Alliance Agreement further provides that Siemens and the Company plan to develop a product concept for future joint technology development and cooperate in good faith to explore additional opportunities for ongoing collaboration on complementary technology developments.
The Alliance Agreement has a five year initial term, which will automatically renew for successive one year terms unless a party gives notice of termination to the other party at least six months before the end of a term.
During the quarter ended December 31, 2010, Siemens reorganized its Healthcare division. To date, Siemens and the Company have not yet agreed on the definition of a specification for the first Cayman Product as originally anticipated, therefore little development work and no milestone payments have occurred. The Company has had discussions with the new management within Siemens Healthcare regarding this project and they have indicated that they are reviewing their plans and considering the potential impact of our announced agreement to acquire TomoTherapy.
4. 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 had entered into an agreement (Rights Agreement) with UBS, which provided the Company with ARS (Auction Rate Security) Rights (Rights) to sell its ARS at par value to UBS at any time during the period June 30, 2010 through July 2, 2012.
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.
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 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, respectively, 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. No activity related to the fair value of the put option is included in the Companys condensed consolidated statement of operations for the three and nine months ended March 31, 2011 due to the liquidation at par value of the underlying ARS securities as of June 30, 2010.
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 1Unadjusted quoted prices that are available in active markets for the identical assets or liabilities at the measurement date.
Level 2Other 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.
Level 3Unobservable 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 in which managements estimate utilizes market participant assumptions.
The following tables set forth by level within the fair value hierarchy the Companys financial instruments that were accounted for at fair value on a recurring basis at March 31, 2011 and June 30, 2010, according to the valuation techniques the Company used to determine their fair values (in thousands):
|
|
Fair Value at |
|
Fair Value Measurements |
| |||||
|
|
March 31, 2011 |
|
Level 1 |
|
Level 2 |
| |||
Money market funds |
|
$ |
17,963 |
|
$ |
17,963 |
|
$ |
|
|
Corporate notes |
|
24,632 |
|
|
|
24,632 |
| |||
Commercial paper |
|
42,558 |
|
|
|
42,558 |
| |||
U.S. government agency securities |
|
22,213 |
|
|
|
22,213 |
| |||
Total |
|
$ |
107,366 |
|
$ |
17,963 |
|
$ |
89,403 |
|
|
|
Fair Value at |
|
Fair Value Measurements |
| |||||
|
|
June 30, 2010 |
|
Level 1 |
|
Level 2 |
| |||
Money market funds |
|
$ |
1,104 |
|
$ |
1,104 |
|
$ |
|
|
Corporate notes |
|
34,992 |
|
|
|
34,992 |
| |||
Commercial paper |
|
22,513 |
|
|
|
22,513 |
| |||
U.S. government agency securities |
|
43,774 |
|
|
|
43,774 |
| |||
Total |
|
$ |
102,383 |
|
$ |
1,104 |
|
$ |
101,279 |
|
As of March 31, 2011 and June 30, 2010, the Company had no assets or liabilities using Level 3 inputs.
Investments in marketable securities classified as available-for-sale by security type at March 31, 2011 and June 30, 2010, consisted of the following (in thousands):
|
|
March 31, 2011 |
| ||||||||||
|
|
|
|
Gross Unrealized |
|
Gross Unrealized |
|
|
| ||||
|
|
Amortized Cost |
|
Gains |
|
Losses |
|
Fair Value |
| ||||
Short-term investments: |
|
|
|
|
|
|
|
|
| ||||
Commercial paper |
|
$ |
38,753 |
|
$ |
12 |
|
$ |
(7 |
) |
$ |
38,758 |
|
Corporate notes |
|
24,630 |
|
9 |
|
(7 |
) |
24,632 |
| ||||
U.S. government agency securities |
|
22,204 |
|
9 |
|
|
|
22,213 |
| ||||
Total short-term investments |
|
$ |
85,587 |
|
$ |
30 |
|
$ |
(14 |
) |
$ |
85,603 |
|
|
|
June 30, 2010 |
| ||||||||||
|
|
|
|
Gross Unrealized |
|
Gross Unrealized |
|
|
| ||||
|
|
Amortized Cost |
|
Gains |
|
Losses |
|
Fair Value |
| ||||
Short-term investments: |
|
|
|
|
|
|
|
|
| ||||
Commercial paper |
|
$ |
21,126 |
|
$ |
|
|
$ |
(11 |
) |
$ |
21,115 |
|
Corporate notes |
|
34,957 |
|
64 |
|
(29 |
) |
34,992 |
| ||||
U.S. government agency securities |
|
43,761 |
|
15 |
|
(2 |
) |
43,774 |
| ||||
Total short-term investments |
|
$ |
99,844 |
|
$ |
79 |
|
$ |
(42 |
) |
$ |
99,881 |
|
As of March 31, 2011 and June 30, 2010, the Company had no long-term investments in marketable securities classified as available-for-sale.
All of the Companys investments with continuous unrealized losses have been in an unrealized loss position for less than twelve months at March 31, 2011. The Company has determined that the gross unrealized losses on its marketable securities at March 31, 2011 were temporary in nature.
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 open-ended mutual funds that typically invest in short-term debt securities. Money market funds are classified as cash and cash equivalents on the Companys condensed consolidated balance sheets. The Company classified these funds that are specifically backed by debt securities as Level 1 instruments due to its usage of unadjusted quoted prices that are available in active markets for the identical assets or liabilities at the measurement date.
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 Companys condensed consolidated balance sheets. The market approach was used to value the Companys 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 130 days. The total fair value of commercial paper held as of March 31, 2011 of $42.6 million includes $3.8 million of money market funds invested in commercial paper which is classified as cash equivalents. The total fair value of commercial paper held as of June 30, 2010 of $22.5 million includes $1.4 million of money market funds invested in commercial paper which is classified as cash equivalents. The portion in cash and cash equivalents represents highly liquid debt instruments with insignificant interest rate risk and maturities of 90 days or less at the time of purchase. The market approach was used to value the Companys 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.
U.S. government agency securities. U.S. government agency securities are issued by U.S. Federal, state and local governments, government-sponsored enterprises, and governmental entities such as authorities or special districts that generally mature within two years. These are classified as short-term and long-term marketable securities on the Companys condensed consolidated balance sheets. The market approach was used to value the Companys U.S. government agency securities. 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.
5. Balance Sheet Components
Accounts receivable, net
Accounts receivable, net consists of the following (in thousands):
|
|
March 31, |
|
June 30, |
| ||
|
|
2011 |
|
2010 |
| ||
Accounts receivable |
|
$ |
44,888 |
|
$ |
37,861 |
|
Unbilled fees and services |
|
208 |
|
209 |
| ||
|
|
45,096 |
|
38,070 |
| ||
Less: Allowance for doubtful accounts |
|
(225 |
) |
(115 |
) | ||
Accounts receivable, net |
|
$ |
44,871 |
|
$ |
37,955 |
|
Inventories
Inventories consist of the following (in thousands):
|
|
March 31, |
|
June 30, |
| ||
|
|
2011 |
|
2010 |
| ||
Raw materials |
|
$ |
18,791 |
|
$ |
13,683 |
|
Work-in-process |
|
6,127 |
|
5,987 |
| ||
Finished goods |
|
9,490 |
|
8,516 |
| ||
Total inventories |
|
$ |
34,408 |
|
$ |
28,186 |
|
Property and Equipment, net
Property and equipment, net consist of the following (in thousands):
|
|
March 31, |
|
June 30, |
| ||
|
|
2011 |
|
2010 |
| ||
Furniture and fixtures |
|
$ |
3,705 |
|
$ |
3,628 |
|
Computer and office equipment |
|
12,438 |
|
8,297 |
| ||
Leasehold improvements |
|
8,023 |
|
7,771 |
| ||
Machinery and equipment |
|
16,963 |
|
15,291 |
| ||
CyberKnife shared ownership systems |
|
3,712 |
|
5,216 |
| ||
Construction In Progress |
|
1,201 |
|
1,927 |
| ||
|
|
46,042 |
|
42,130 |
| ||
Less: Accumulated depreciation and amortization |
|
(29,528 |
) |
(27,446 |
) | ||
Property and equipment, net |
|
$ |
16,514 |
|
$ |
14,684 |
|
Depreciation and amortization expense related to property and equipment for the three and nine months ended March 31, 2011 was $1.5 million and $4.3 million, respectively. 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. Accumulated depreciation related to the CyberKnife systems attributable to the shared ownership program as of March 31, 2011 and June 30, 2010 was $2.0 million and $1.8 million, respectively.
During the third quarter of fiscal 2011, the Company implemented a new enterprise resource planning information system for $3.8 million. The costs were primarily related to license and consulting fees and were previously capitalized as construction in progress.
Of the $1.2 million recorded in construction in progress at March 31, 2011, $0.5 million was related to leasehold improvements and $0.4 million was related to machinery and equipment.
6. 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 Companys treatment planning software. The equity investment afforded the Company a voting interest of approximately 18% in Morphormics. The Companys equity was considered to be at risk and was deemed not sufficient to finance Morphormics current product development activities without additional subordinated financial support. In addition, the Company was deemed to be Morphormics primary beneficiary, therefore, it would absorb a majority of expected losses. The Company consolidated Morphormics in its financial results. The consolidation of Morphormics assets and liabilities did not have a material effect on the Companys consolidated balance sheet at June 30, 2010. The Company recorded losses on this investment for the three and nine months ended March 31, 2010 of $0.1 million and $0.5 million, respectively. As of June 30, 2010, the investment amount had been substantially utilized by Morphormics.
Effective July 1, 2010, the determination of primary beneficiary status has changed from a quantitative approach to a qualitative approach under which the Company is no longer considered the primary beneficiary of Morphormics. The Company has deconsolidated Morphormics assets and liabilities from its consolidated balance sheet as of July 1, 2010. The deconsolidation of the Companys investment in Morphormics resulted in a net cumulative-effect adjustment to accumulated deficit of $27,000 on the Companys condensed consolidated balance sheet.
As of July 1, 2010, the Company determined the fair value of the investment using an income approach. The assumptions for the valuation included historical financial data, operating projections, estimated future cash flows and an adjustment for lack of liquidity.
7. 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 Companys operations and seek unspecified monetary damages and other relief. On August 31, 2010, the Court granted defendants motion to dismiss the consolidated complaint and granted plaintiffs leave to file an amended complaint. On September 27, 2010, plaintiffs filed an amended complaint. The amended complaint names the Company and certain of its current and former officers and directors as defendants and generally alleges that the defendants made false or misleading public statements regarding the Companys operations. The amended complaint seeks unspecified monetary damages and other relief. Defendants filed a motion to dismiss the amended complaint. On April 28, 2011, the parties filed a stipulation of settlement with the court, providing for the settlement of the litigation for a payment of $13.5 million covered by insurance. The settlement is subject to notice to the members of the class and the approval of the court.
On August 5, 2009, a shareholder derivative lawsuit was filed in Santa Clara County Superior Court against certain of the Companys 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 Companys 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 Companys 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 Companys 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 August 31, 2010, the Court granted defendants motion to dismiss, with leave to amend. On September 27, 2010, plaintiffs filed a notice of their intent not to file an amended complaint. On October 6, 2010, judgment was entered and the action dismissed. Plaintiffs filed a notice of appeal to the U.S. Court of Appeals for the Ninth Circuit on November 8, 2010. On March 15, 2011, the parties filed a joint motion to voluntarily dismiss the appeal without prejudice and to remand the action to the district court for consideration of the settlement. On March 16, 2011, the parties filed their Stipulation of Settlement and plaintiffs filed an unopposed motion for approval of the settlement. A hearing on final approval of the settlement was held on May 5, 2011. The court approved the settlement for a payment of $0.8 million which will be fully covered by insurance, and entered final judgment on May 6, 2011.
On February 14, 2011, a purported shareholder filed a complaint in Santa Clara County Superior Court naming as defendants certain of the Companys current and former officers and directors. The Company is named as a nominal defendant. The complaint generally copied the allegations of the federal derivative action and also alleged that a litigation demand concerning such allegations was wrongfully denied. On March 24, 2011, the plaintiff filed an amended complaint. On April 28, 2011, the Company and a number of individual defendants filed demurrers to the amended complaint.
On March 15, 2011, two purported class action complaints were filed in the Circuit Court for the State of Wisconsin, Dane County, on behalf of a putative class of TomoTherapy Incorporated (TomoTherapy) shareholders and naming as defendants TomoTherapy, TomoTherapys board of directors, the Company and Jaguar Acquisition, Inc., a wholly-owned subsidiary of the Company (Merger Sub). The complaints generally allege that, in connection with the Companys proposed merger transaction with TomoTherapy, TomoTherapys board breached their fiduciary duties by, among other things, failing to maximize the value of TomoTheapy to its shareholders and purportedly agreeing to certain terms in the merger agreement which are allegedly preclusive and onerous. The complaints further allege that the Company and Merger Sub aided and abetted TomoTherapys board of directors in their alleged breaches of fiduciary duties. The plaintiffs seek, among other things, an injunction barring consummation of the merger, rescission or recessionary damages, costs and attorneys fees. The Company and Merger Sub were dismissed from the litigation without prejudice on April 19, 2011.
On September 3, 2009, Best Medical International, Inc. (Best Medical) filed a lawsuit against the Company in the U.S. District Court for the Western District of Pennsylvania, claiming the Company induced certain individuals to leave the employment of Best Medical and join the Company in order to gain access to Best Medicals 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.
On August 6, 2010, Best Medical filed an additional lawsuit against the Company in the U.S. District Court for the Western District of Pennsylvania, claiming the Company has infringed U.S. Patent No. 5,596,619, a patent that Best Medical alleges protects a method and apparatus for conformal radiation therapy. On December 2, 2010, the Court granted the Companys motion to dismiss, with leave to amend. On December 16, 2010, Best Medical filed an amended complaint, claiming that the Company also infringes U.S. Patent Nos. 6,038,283 and 7,266,175, both of which Best Medical alleges cover methods and apparatus for conformal radiation therapy. On March 9, 2011, the Court dismissed with prejudice all counts against the Company, except for two counts of alleged willful infringement of two of the patents. Best Medical is seeking declaratory and injunctive relief as well as unspecified compensatory and treble damages and other relief. At this time, the Company does not have enough information to estimate what, if any, financial impact this claim will have.
As of March 31, 2011, the Company has not recorded any liabilities for the above referenced lawsuits as we are unable to determine if a loss is probable or estimable with the exception of the shareholder lawsuits which are fully covered by the Companys insurance polices.
Software License Indemnity
Under the terms of the Companys 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, 2011.
8. Stock-Based Compensation
The following table summarizes the stock-based compensation charges included in the Companys condensed consolidated statements of operations (in thousands):
|
|
Three Months Ended March 31, |
|
Nine Months Ended March 31, |
| ||||||||
|
|
2011 |
|
2010 |
|
2011 |
|
2010 |
| ||||
Cost of revenue |
|
$ |
242 |
|
$ |
492 |
|
$ |
886 |
|
$ |
1,168 |
|
Selling and marketing |
|
155 |
|
(84 |
) |
512 |
|
1,379 |
| ||||
Research and development |
|
499 |
|
636 |
|
1,793 |
|
1,937 |
| ||||
General and administrative |
|
1,048 |
|
839 |
|
3,204 |
|
3,753 |
| ||||
|
|
$ |
1,944 |
|
$ |
1,883 |
|
$ |
6,395 |
|
$ |
8,237 |
|
At March 31, 2011 and June 30, 2010, capitalized stock-based compensation costs of $0.3 million and $0.2 million, respectively, were included as components of inventories.
9. Goodwill and Other Purchased Intangibles
Goodwill and other intangible assets resulted from the Companys January 2005 acquisition of the HES division of American Science and Engineering, Inc. 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 performed the annual test for impairment of goodwill in December 2010 concluding that there was no impairment of goodwill. The amortization expense related to intangible assets for the three months ended March 31, 2011 and 2010 was $0.1 million and $0.1 million, respectively. The following table represents the gross carrying amounts and accumulated amortization of amortized intangible assets at March 31, 2011 and June 30, 2010 (in thousands):
|
|
March 31, |
|
June 30, |
| ||
|
|
2011 |
|
2010 |
| ||
Complete technology |
|
$ |
1,740 |
|
$ |
1,740 |
|
Customer contract / relationship |
|
70 |
|
70 |
| ||
|
|
1,810 |
|
1,810 |
| ||
Less: Accumulated amortization |
|
(1,616 |
) |
(1,422 |
) | ||
Intangible assets, net |
|
$ |
194 |
|
$ |
388 |
|
The following table represents the estimated useful life of the intangible assets subject to amortization:
|
|
Years |
|
Amortized Intangible Assets: |
|
|
|
Complete technology |
|
7.0 |
|
Customer contract / relationship |
|
7.0 |
|
The estimated future amortization expense of purchased intangible assets as of March 31, 2011, is as follows (in thousands):
Year ending June 30, |
|
|
| |
2011 (remaining three months) |
|
$ |
65 |
|
2012 |
|
129 |
| |
Total |
|
$ |
194 |
|
10. Subsequent Event
On March 6, 2011, the Company agreed to acquire TomoTherapy for approximately $268.1 million in cash and shares of the Companys common stock. Upon the closing of the acquisition, the Company will pay $3.15 in cash and 0.1648 shares of the Companys common stock for each issued and outstanding share of TomoTherapys common stock. The acquisition of TomoTherapy is expected to close in the fourth quarter of fiscal 2011 or the first quarter of fiscal 2012, but remains subject to certain customary closing conditions.
Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition as of March 31, 2011 and results of operations for the three and nine months ended March 31, 2011 and 2010 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, including statements regarding the extent and timing of future revenues and expenses, statements regarding reimbursement rates, statements regarding regulatory requirements, statements regarding future orders, statements regarding our strategic alliance with Siemens AG, statements regarding the manufacture and deployment of our products, statements regarding market position, sales cycle, revenues, earnings or other financial results, statements regarding the proposed transaction with TomoTherapy, including the estimated dates for closing, and other statements using words such as anticipates, believes, could, estimates, expects, forecasts, intends, may, plans, projects, should, will and would, and words of similar import and the negatives thereof. 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 II, Item 1A of this quarterly report on Form 10-Q. We encourage you to read that section carefully. 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.
In this report, Accuray, the Company, we, us, and our refer to Accuray Incorporated.
Recent Developments
On March 6, 2011, we entered into an Agreement and Plan of Merger, with TomoTherapy Incorporated, a Wisconsin corporation (TomoTherapy) and Jaguar Acquisition, Inc., a Wisconsin corporation and wholly-owned subsidiary of Accuray (Merger Sub). Pursuant to the terms of the definitive agreement, and subject to the satisfaction or waiver of closing conditions, including the approval of TomoTherapys shareholders, receipt by TomoTherapy of certain third-party consents and the deposit by TomoTherapy of $65.0 million in cash into a TomoTherapy account with the exchange agent, Merger Sub will merge with and into TomoTherapy, and TomoTherapy will become a wholly owned subsidiary of the Company (the Transaction). If the Transaction were to close, we would pay to TomoTherapy stockholders approximately $268.1 million, or $4.80 per share of TomoTherapy common stock, in a combination of cash ($3.15 per share) and stock (0.1648 shares of Accuray common stock per share of TomoTherapy common stock), subject to adjustment. The Merger Agreement contains certain customary termination rights for each of TomoTherapy and the Company, and under certain circumstances, TomoTherapy will be required to pay a termination fee of $8.0 million and under other circumstances, TomoTherapy will be required to reimburse us up to $1.5 million in expenses.
TomoTherapy is the creator of advanced radiation therapy solutions for cancer care. TomoTherapy, together with its affiliates, develops, manufactures, markets and sells advanced radiation therapy solutions to treat a wide range of cancer types. TomoTherapy markets its products to hospitals and cancer treatment centers in the Americas, Europe, the Middle East and Asia-Pacific and offers customer support services in each region directly or through third-party distributors. TomoTherapys common stock is traded on NASDAQ under the symbol TOMO. As of December 31, 2010, TomoTherapy had $270.0 million of assets, including $152.0 million in cash, cash equivalents and short term investments, and $163.0 million in shareholders equity.
The closing of the Transaction, subject to satisfaction or waiver of all closing conditions, is expected to occur in June or July of 2011. For more detailed information, including benefits, risks and uncertainties regarding the Transaction, please see our Registration Statement on Form S-4 filed with the SEC on April 7, 2011, as amended, declared effective on May 6, 2011.
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. Physicians determine when and how the CyberKnife system should be used in the treatment of patients. The CyberKnife system is designed to treat small to medium sized, discrete tumors, and is generally not used to treat (1) very large tumors, which are considerably wider than the radiation beam that can be delivered by the CyberKnife system, (2) diffuse, wide-spread disease, as is often the case for late stage cancers, because they are not localized (though the CyberKnife system might be used to treat a focal area of the disease) and (3) systemic disease, like leukemias and lymphomas, which are not localized to an organ, but rather involve cells throughout the body.
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 tumors location and transmit any position corrections to the robotic arm prior to delivery of each dose of radiation. Our compact linear accelerator, or 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.
By way of an overview, in order to operate our business, we are required to first obtain regulatory clearances from governmental agencies in the United States and abroad to market our CyberKnife system, establish an effective and secure supply chain of materials and systems that we then manufacture and assemble to create the CyberKnife system, establish direct and distributor sales channels for the sales of our products, provide for ongoing sales and service supports for our products in the field and manage the attendant risks associated with our operations, including risks beyond our control, such as changes in healthcare legislation and Medicare reimbursement rates, which necessarily affect the decisions of physicians and hospitals regarding the purchase of our products.
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 117,000 patient treatments.
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.
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, 2011, we had 41 employees in our sales organization.
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.
Our CyberKnife systems are either sold to our customers or placed with our customers pursuant to our shared ownership program. As of March 31, 2011, we had 226 CyberKnife systems installed at customer sites, including 223 sold and three pursuant to our shared ownership program. Of the 226 systems installed, 140 are in the Americas, 49 are in Asia and 37 are in Europe.
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 warranty up to two years. 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 program is our Diamond program, which consists of both our Diamond Elite multiyear service plan, or original Diamond Plan, and our new Diamond Plus multiyear service plan, or Diamond Plus Plan. We introduced our Diamond Plus Plan in the United States during the quarter ended September 30, 2010, and since its implementation, new U.S. customers may purchase the Diamond Plus Plan. Under our original Diamond Plan, customers are eligible to receive up to two upgrades (software or hardware only) per year, when and if available, and under our Diamond Plus Plan, customers are eligible to receive up to twenty upgrades (hardware or
software) per year, when and if available, or support services, or a combination of upgrades and support services. Each upgrade available under the Diamond Plus Plan has a value equal to one-tenth the value of the upgrades available under the original Diamond Plan. Prior to introducing our original 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, 2011 and 2010, 176 out of 180 and 141 out of 153, respectively, of our customers with service plans 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. Coverage and payment currently exist in the hospital outpatient setting and in the freestanding clinic setting. For calendar year 2011, the national unadjusted average Medicare payment rates under Healthcare Common Procedure Coding System, or HCPCS, are $3,409 under code G0339, the billing code for the first treatment, and $2,505 under code G0340, the billing code for each of the second through fifth treatments. The final rates in the hospital outpatient setting reflect a 4.6% decrease for G0339 ($3,409) and a 0.7% increase for G0340 ($2,505) compared to 2010. Payment for the freestanding clinic setting is governed by the final Medicare Physician Fee Schedule. For 2011, 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.
In addition to Medicare reimbursement to hospitals and clinics, physicians receive reimbursement for their professional services in the hospital outpatient setting and the freestanding clinic setting. Payment to physicians is based on the Medicare Physician Fee Schedule, and payment amounts are updated on an annual basis. For 2011, Medicare increased reimbursement rates for the Current Procedural Terminology, or CPT, code series describing the surgeons role in the delivery of CyberKnife cranial and spinal procedures beginning with 61796 and 63620 to varying degrees ranging from 17% to 23% compared to 2010. 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 strereotactic radiosurgery treatment decreased by two percent.
Our CyberKnife VSI system, introduced in November 2009, allows physicians to perform conventionally fractioned robotic image guided intensity-modulated radiation therapy, or Robotic IMRTTM, in addition to robotic stereotactic radiosurgery procedures. Medicare 2011 final physician fee schedule rules reflect a two percent increase over 2010 for the treatment delivery code used to report IMRT services delivered by the CyberKnife VSI system.
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
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 typically 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 relative selling price of at least one year of service, training and other professional services, if applicable. We recognize the relative selling price of the first year of service as
revenue pro rata over the twelve months following installation, training and other professional services, as delivered. In addition, if the customer has purchased either of our Diamond service plans or our Emerald service 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 original 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 would be 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, when available, 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 in place at the time we entered into these agreements, 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. As of the end of June 2010, we had installed the final upgrades on all systems sold under Platinum agreements. We anticipate that we will satisfy our final obligations under the remaining Platinum service plans mainly during fiscal 2011, with an immaterial amount to complete in fiscal 2012.
Warranty
All customers purchasing a CyberKnife system receive up to a two year warranty. We recognize the CyberKnife system purchase price, minus the relative selling price of support services, upon installation if we are responsible for providing installation or otherwise on shipment. We recognize the relative selling price of the support services ratably over the corresponding period following installation.
Shared Ownership Program Revenue
We recognize revenue, consisting of a minimum monthly payment, monthly from our shared ownership program. 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 $0.3 million and $1.9 million for the three and nine months ended March 31, 2011, respectively. 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. 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 service 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 service support.
For international sales, we recognize revenue once we have met all of our obligations associated with the purchase agreement, other than for undelivered elements at their relative selling price. 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 upon shipment provided that we have received proof of sell-through to the end user from the distributor and that all of our remaining obligations have been satisfied. Net revenue from international customers was $26.7 million and $57.1 million for the three and nine months ended March 31, 2011, respectively. Net revenue from international customers was $21.7 million and $53.7 million for the three and nine months ended March 31, 2010, respectively. The increase in international revenue for the three months ended March 31, 2011 was a result principally from the increase in orders in the Europe and Japan regions.
Backlog
Backlog consists of the sum of deferred revenue, future un-invoiced payments that our customers are contractually committed to make, signed, non-contingent CyberKnife system sale agreements that meet the detailed criteria set forth below, service plans and minimum payment requirements associated with our shared ownership program. In order for a CyberKnife system sale agreement to be counted as backlog, it must meet the following criteria:
· The contract is signed and properly executed by both the customer and us;
· The contract is non-contingentit either has cleared all its contingencies or contains no contingencies when signed;
· We have received a deposit or a letter of credit, or the sale is a direct channel sale to a government entity;
· The specific end customer site has been identified by the customer in the written contract or written amendment; and
· Less than 2.5 years have passed since the contract met all the criteria above.
Included in customers agreements to purchase a CyberKnife system is an option to select the type and term of service coverage that they desire. Backlog includes the value of this service coverage selected by customers in their original agreement to purchase a CyberKnife system. Before installation of the CyberKnife system is complete and service commences, the customer must complete and sign a separate service agreement for service coverage (i.e., Diamond or Emerald service). If at the time of signing the service agreement a customer selects a different type of service than the option selected in the CyberKnife system purchase agreement, our backlog is adjusted to reflect the service agreement the customer signed.
At March 31, 2011 and 2010, our backlog was approximately $414.3 million and $350.0 million, respectively. Of the total backlog, $160.1 million and $124.9 million represented CyberKnife system sales at March 31, 2011 and 2010, respectively, and $254.2 million and $225.1 million represented revenue from service plans and other recurring revenues at March 31, 2011 and 2010, respectively. We anticipate that this backlog will be recognized over the next five years as installations occur, upgrades are delivered and services are provided.
Although our backlog includes only contractual agreements from our customers, we cannot make assurances that we will convert it into recognized revenue due to factors outside our control including without limitation, changes in customers needs, changes in reimbursement, changes to regulatory requirements, or other cancellation of orders.
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), 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 services and other non-medical products).
Deferred RevenuePlatinum Multiyear Service Plans. We are required to defer all of the revenue associated with our Platinum plan, until we have satisfied all of the specified obligations related to the delivery of upgrades to the CyberKnife system during the life of the service plan. This includes deferring revenue for the cash received for the purchase of the CyberKnife system and Platinum service plans until we have delivered all upgrades which the customer is eligible to receive. Once we have satisfied our obligations for delivery of upgrades under the plan, we recognize revenue ratably over the remaining life of the service contract term. We have not offered the Platinum service plan to new customers since we phased it out when we introduced our original Diamond plan in November 2005. As of the end of June 2010, we had installed the final upgrades on all systems sold under Platinum agreements.
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, net. Other income, net consists primarily of interest earned on our cash and cash equivalents and investments, unrealized losses on our long-term trading securities, net of unrealized gains on our put option, foreign currency transaction gains and losses, gains and losses on fixed asset disposals, and state and local sales and use tax fines and penalties.
Three and Nine Months Ended March 31, 2011 Compared to Three and Nine Months Ended March 31, 2010
Net Revenue
|
|
Three Months Ended |
|
|
|
|
|
Nine Months Ended |
|
|
|
|
| ||||||||||
|
|
March 31, |
|
Variance in |
|
Variance in |
|
March 31, |
|
Variance in |
|
Variance in |
| ||||||||||
(Dollars in thousands) |
|
2011 |
|
2010 |
|
Dollars |
|
Percent |
|
2011 |
|
2010 |
|
Dollars |
|
Percent |
| ||||||
Products |
|
$ |
35,249 |
|
$ |
33,783 |
|
$ |
1,466 |
|
4 |
% |
$ |
88,915 |
|
$ |
99,815 |
|
$ |
(10,900 |
) |
(11 |
)% |
Shared ownership program |
|
335 |
|
484 |
|
(149 |
) |
(31 |
)% |
1,856 |
|
1,421 |
|
435 |
|
31 |
% | ||||||
Services |
|
18,253 |
|
17,545 |
|
708 |
|
4 |
% |
54,833 |
|
57,887 |
|
(3,054 |
) |
(5 |
)% | ||||||
Other |
|
910 |
|
128 |
|
782 |
|
611 |
% |
1,457 |
|
714 |
|
743 |
|
104 |
% | ||||||
Net Revenue |
|
$ |
54,747 |
|
$ |
51,940 |
|
$ |
2,807 |
|
5 |
% |
$ |
147,061 |
|
$ |
159,837 |
|
$ |
(12,776 |
) |
(8 |
)% |
Total net revenue for the three months ended March 31, 2011 increased $2.8 million from the three months ended March 31, 2010. Excluding revenue recognized for systems sold under our Platinum plan, we recognized $35.0 million and $31.7 million of product revenue for the three months ended March 31, 2011 and 2010, respectively. Excluding revenue under Platinum service agreements, service revenue totaled $17.9 million for the three months ended March 31, 2011, up $2.7 million from the three months ended March 31, 2010 as a result of continued growth in our installed base covered by service plans. As of March 31, 2011 and 2010, 176 out of 180 and 141 out of 153 of our customers that had purchased service plans, respectively, had purchased non-Platinum service plans.
We recognized $0.6 million of revenue for the three months ended March 31, 2011 from systems sold under our Platinum plan, consisting of $0.2 million for product revenue and $0.4 million for service revenue. All Platinum product revenue for this period was deferred from prior periods. Platinum service revenue for this period included $0.3 million deferred from prior periods. By comparison, we recognized $4.5 million of revenue for the three months ended March 31, 2010 from systems sold under our Platinum plan, including $2.1 million for product revenue and $2.4 million for service revenue. All Platinum product revenue for the three months ended March 31, 2010 was deferred from prior periods. Platinum service revenue for this period included $1.4 million deferred from prior periods. As of June 30, 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, 2011 decreased $12.8 million from the nine months ended March 31, 2010. Excluding revenue recognized for systems sold under our Platinum plan, we recognized $87.1 million and $88.9 million of product revenue for the nine months ended March 31, 2011 and 2010, respectively. Excluding revenue under Platinum service agreements, service revenue totaled $51.9 million for the nine months ended March 31, 2011, up $6.9 million from the nine months ended March 31, 2010 as a result of continued growth in our installed base covered by service plans.
We recognized $4.8 million of revenue for the nine months ended March 31, 2011 from systems sold under our Platinum plan, consisting of $1.8 million for product revenue and $3.0 million for service revenue. All Platinum product revenue for this period was deferred from prior periods. Platinum service revenue for this period included $1.7 million deferred from prior periods. By comparison, we recognized $23.9 million of revenue for the nine months ended March 31, 2010 from systems sold under our Platinum plan, including $10.9 million for product revenue and $13.0 million for service revenue. All Platinum product revenue for this period was deferred from prior periods. Platinum service revenue for this period included $5.1 million deferred from prior periods.
We anticipate our non-Platinum revenue to continue to grow in future periods, while we expect Platinum revenue to decrease in future periods as these legacy arrangements lapse. Additionally, we expect our service revenue to increase as our installed base continues to grow.
Gross Profit (Loss)
|
|
Three Months Ended March 31, |
|
Nine Months Ended March 31, |
| ||||||||||||||||
|
|
2011 |
|
2010 |
|
2011 |
|
2010 |
| ||||||||||||
|
|
(Dollars in |
|
(% of net |
|
(Dollars in |
|
(% of net |
|
(Dollars in |
|
(% of net |
|
(Dollars in |
|
(% of net |
| ||||
|
|
thousands) |
|
revenue) |
|
thousands) |
|
revenue) |
|
thousands) |
|
revenue) |
|
thousands) |
|
revenue) |
| ||||
Gross profit (loss) |
|
$ |
27,313 |
|
49.9 |
% |
$ |
25,376 |
|
48.9 |
% |
$ |
75,016 |
|
51.0 |
% |
$ |
72,960 |
|
45.6 |
% |
Products |
|
$ |
21,135 |
|
60.0 |
% |
$ |
19,353 |
|
57.3 |
% |
$ |
54,407 |
|
61.2 |
% |
$ |
53,177 |
|
53.3 |
% |
Shared ownership program |
|
$ |
250 |
|
74.6 |
% |
$ |
256 |
|
52.9 |
% |
$ |
1,477 |
|
79.6 |
% |
$ |
544 |
|
38.3 |
% |
Services |
|
$ |
6,101 |
|
33.4 |
% |
$ |
5,739 |
|
32.7 |
% |
$ |
19,436 |
|
35.4 |
% |
$ |
19,028 |
|
32.9 |
% |
Other |
|
$ |
(173 |
) |
-19.0 |
% |
$ |
28 |
|
21.9 |
% |
$ |
(304 |
) |
-20.9 |
% |
$ |
211 |
|
29.6 |
% |
Gross margin as a percentage of net revenue was relatively unchanged in the three months ended March 31, 2011 compared to the three months ended March 31, 2010. Gross margin as a percentage of net revenue for the nine months ended March 31, 2011 increased from 45.6% to 51.0% compared to the nine months ended March 31, 2010. The increase in product, shared ownership program and service gross margin as a percentage of net revenue for the three and nine months ended March 31, 2011 compared to the three and nine months ended March 31, 2010 was primarily the result of an increase in average selling price and decreases in manufacturing costs. Additionally, service gross margins have increased for the three and nine months ended March 31, 2011 compared to the three and nine months ended March 31, 2010 primarily due to the growth in our installed base coupled with consistent levels of service labor costs and a reduction in service parts costs.
Selling and Marketing
|
|
Three Months Ended |
|
|
|
|
|
Nine Months Ended |
|
|
|
|
| ||||||||||
|
|
March 31, |
|
Variance in |
|
Variance in |
|
March 31, |
|
Variance in |
|
Variance in |
| ||||||||||
(Dollars in thousands) |
|
2011 |
|
2010 |
|
Dollars |
|
Percent |
|
2011 |
|
2010 |
|
Dollars |
|
Percent |
| ||||||
Sales and marketing |
|
$ |
8,127 |
|
$ |
7,179 |
|
$ |
948 |
|
13 |
% |
$ |
23,874 |
|
$ |
25,891 |
|
$ |
(2,017 |
) |
(8 |
)% |
Percentage of net revenue |
|
14.8 |
% |
13.8 |
% |
|
|
|
|
16.2 |
% |
16.2 |
% |
|
|
|
| ||||||
Selling and marketing expenses for the three months ended March 31, 2011 increased $0.9 million compared to the three months ended March 31, 2010. The increase was primarily attributable to increased tradeshow and marketing events including travel for $0.3 million, an increase in consulting related expenses of $0.3 million principally for the assistance in the announcement and ongoing integration planning of the proposed acquisition of TomoTherapy, and an increase in stock-based compensation expense of $0.2 million.
Selling and marketing expenses for the nine months ended March 31, 2011 decreased $2.0 million compared to the nine months ended March 31, 2010. The decrease was primarily attributable to a decrease in compensation and employee related expenses, including commission, bonus and stock-based compensation of $2.1 million, offset by an increase of $0.2 million in travel related expenses.
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
|
|
Three Months Ended |
|
|
|
|
|
Nine Months Ended |
|
|
|
|
| ||||||||||
|
|
March 31, |
|
Variance in |
|
Variance in |
|
March 31, |
|
Variance in |
|
Variance in |
| ||||||||||
(Dollars in thousands) |
|
2011 |
|
2010 |
|
Dollars |
|
Percent |
|
2011 |
|
2010 |
|
Dollars |
|
Percent |
| ||||||
Research and development |
|
$ |
9,291 |
|
$ |
7,719 |
|
$ |
1,572 |
|
20 |
% |
$ |
26,651 |
|
$ |
23,150 |
|
$ |
3,501 |
|
15 |
% |
Percentage of net revenue |
|
17.0 |
% |
14.9 |
% |
|
|
|
|
18.1 |
% |
14.5 |
% |
|
|
|
| ||||||
Research and development expenses for the three months ended March 31, 2011 increased $1.6 million compared to the three months ended March 31, 2010. The increase was primarily attributable to increased consulting fees of $1.1 million for internal development projects, along with sponsorship of clinical research studies, and a net increase of $0.2 million for employee and related expenses, including temporary labor, to support increases in our research and development activities.
Research and development expenses for the nine months ended March 31, 2011 increased $3.5 million compared to the nine months ended March 31, 2010. The increase was primarily attributable to an increase in compensation and employee related costs, including contract labor, recruiting and relocation of $0.8 million to support ongoing research projects and increased consulting fees of $2.5 million for internal development projects, along with externally sponsored clinical research programs.
We anticipate research and development expense to be higher in the fourth quarter of fiscal year 2011 compared to the previous quarters of fiscal year 2011 due to development projects designed to continue to advance the capabilities of the CyberKnife system.
General and Administrative
|
|
Three Months Ended |
|
|
|
|
|
Nine Months Ended |
|
|
|
|
| ||||||||||
|
|
March 31, |
|
Variance in |
|
Variance in |
|
March 31, |
|
Variance in |
|
Variance in |
| ||||||||||
(Dollars in thousands) |
|
2011 |
|
2010 |
|
Dollars |
|
Percent |
|
2011 |
|
2010 |
|
Dollars |
|
Percent |
| ||||||
General and administrative |
|
$ |
10,421 |
|
$ |
7,719 |
|
$ |
2,702 |
|
35 |
% |
$ |
27,461 |
|
$ |
27,079 |
|
$ |
382 |
|
1 |
% |
Percentage of net revenue |
|
19.0 |
% |
14.9 |
% |
|
|
|
|
18.7 |
% |
16.9 |
% |
|
|
|
| ||||||
General and administrative expenses for the three months ended March 31, 2011 increased $2.7 million compared to the three months ended March 31, 2010. The increase was primarily attributable to accounting, legal and consulting fees of $2.4 million incurred in connection with our announced proposed acquisition of TomoTherapy.
General and administrative expenses for the nine months ended March 31, 2011 increased $0.4 million compared to the nine months ended March 31, 2010. The increase was primarily attributable to the accounting, legal and consulting expenses of $2.5 million due to our announced proposed acquisition of TomoTherapy, partially offset by a reduction in rent expense of $0.6 million from our renewed lease agreement, lower outside services expense for consulting, audit and legal fees of $0.9 million, partially associated with decreases in costs incurred by us in the ongoing class action shareholder lawsuit, and a decrease of $0.5 million in stock-based compensation.
We anticipate general and administrative expense to be higher in the fourth quarter of 2011 compared to the previous quarters of 2011 due to the acquisition of TomoTherapy.
Other Income (Loss), Net
|
|
Three Months Ended |
|
|
|
|
|
Nine Months Ended |
|
|
|
|
| ||||||||||
|
|
March 31, |
|
Variance in |
|
Variance in |
|
March 31, |
|
Variance in |
|
Variance in |
| ||||||||||
(Dollars in thousands) |
|
2011 |
|
2010 |
|
Dollars |
|
Percent |
|
2011 |
|
2010 |
|
Dollars |
|
Percent |
| ||||||
Other income (loss), net |
|
$ |
22 |
|
$ |
(227 |
) |
$ |
249 |
|
(110 |
)% |
$ |
2,314 |
|
$ |
684 |
|
$ |
1,630 |
|
238 |
% |
Percentage of net revenue |
|
0.0 |
% |
-0.4 |
% |
|
|
|
|
1.6 |
% |
0.4 |
% |
|
|
|
| ||||||
Other income (loss), net, increased $0.2 million for the three months ended March 31, 2011 compared to the three months ended March 31, 2010. The increase was primarily attributable to lower foreign currency transaction losses of $0.4 million, partially offset by a decrease in net interest income of $0.2 million.
Other income (loss), net, increased $1.6 million for the nine months ended March 31, 2011 compared to the nine months ended March 31, 2010. The increase was primarily attributable to an increase of $2.8 million related to foreign currency transaction gains as a result of the appreciation of the Euro-U.S. dollar foreign exchange rate and its effects on the remeasurement of balances and translation of transactions denominated in Euros. This was partially offset by a decrease in net interest income of $1.0 million due to lower average interest rates earned on amounts kept in interest bearing accounts during the nine months ended March 31, 2011, compared to the nine months ended March 31, 2010 and a decrease of $0.2 million related to the loss on sale of investments.
Provision for Incomes Taxes
|
|
Three Months Ended |
|
|
|
|
|
Nine Months Ended |
|
|
|
|
| ||||||||||
|
|
March 31, |
|
Variance in |
|
Variance in |
|
March 31, |
|
Variance in |
|
Variance in |
| ||||||||||
(Dollars in thousands) |
|
2011 |
|
2010 |
|
Dollars |
|
Percent |
|
2011 |
|
2010 |
|
Dollars |
|
Percent |
| ||||||
Provision for (benefit from) income taxes |
|
$ |
656 |
|
$ |
260 |
|
$ |
396 |
|
152 |
% |
$ |
1,046 |
|
$ |
(297 |
) |
$ |
1,343 |
|
(452 |
)% |
Percentage of net revenue |
|
1.2 |
% |
0.5 |
% |
|
|
|
|
0.7 |
% |
-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.
Income tax expense was $0.7 million for the three months ended March 31, 2011, compared to income tax expense of $0.3 million for the three months ended March 31, 2010. The increase in tax expense of $0.4 million is primarily related to an increase in corporate earnings of foreign subsidiaries.
Income tax expense was $1.0 million for the nine months ended March 31, 2011, compared to the income tax benefit of $0.3 million for the nine months ended March 31, 2010. The increase in tax expense of $1.3 million is related primarily to a $0.4 million increase in tax expense associated with foreign earnings, and the remaining $0.9 million is related to a benefit realized from the carryback of fiscal year 2009 US alternative minimum tax losses to earlier years during the nine months ended March 31, 2010.
Stock-Based Compensation Expense
Stock-based compensation expense was recorded net of estimated forfeitures for the three and nine months ended March 31, 2011 and 2010 such that expense was recorded only for those stock-based awards that are expected to vest. For the three months
ended March 31, 2011 and 2010, we recorded $1.9 million and $1.9 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. For the nine months ended March 31, 2011 and 2010, we recorded $6.4 million and $8.2 million, respectively, of comparable stock-based compensation expense. The decrease in stock-based compensation for the nine months ended March 31, 2011 was primarily attributable to a decrease in fair value of our stock options.
Liquidity and Capital Resources
At March 31, 2011, we had $143.0 million in cash, cash equivalents and marketable securities. We believe that we have sufficient cash resources and anticipated cash flows to continue in operation for at least the next twelve months.
On March 6, 2011, we signed a definitive agreement to acquire TomoTherapy for $268.1 million in cash and shares of our common stock. We expect this transaction to close in the fourth quarter of fiscal 2011 or the first quarter of fiscal 2012, but remains subject to certain customary closing conditions. The acquisition agreement is further described in the section entitled Recent Developments above.
Cash Flows From Operating Activities
Net cash used in operating activities was $9.1 million for the nine months ended March 31, 2011. Our net loss of $1.7 million contributed to the negative cash flows from working capital changes including a decrease in deferred revenue, net of deferred cost of revenue of $2.3 million, an increase in inventories of $7.8 million, and a decrease in accounts payable of $3.0 million. This was offset primarily by an increase in accounts receivable of $6.2 million. The change in deferred revenue, net of deferred cost of revenue, was primarily due to timing differences between invoicing customers for products and services and the recognition of the invoicing as revenue. Increases in inventory were due to increases in production while the decrease in accounts payable was due to timing differences between the receipt of goods and service and vendor payments. Non-cash charges included $6.4 million of stock-based compensation charges, $4.4 million of depreciation and amortization expense, and write-down of inventories of $0.7 million.
Net cash used in operating activities was $12.4 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, and a $5.5 million increase in prepaid expenses and other assets, partially offset by a $1.5 million increase in accrued liabilities, a $0.7 million decrease in accounts receivable and a decrease in inventory of $0.6 million. 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, $5.6 million of depreciation and amortization expense, and write-down of inventories of $0.3 million.
Cash Flows From Investing Activities
Net cash provided by investing activities was $16.0 million for the nine months ended March 31, 2011, which was primarily attributable to net marketable security activities of $20.1 million, which consisted of $120.8 million of sales and maturities of marketable securities, offset by $100.7 million in purchases, and $4.1 million of cash used for purchases of property and equipment.
Net cash provided by investing activities was $9.5 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.
Cash Flows From Financing Activities
Net cash provided by financing activities of $4.3 million for the nine months ended March 31, 2011 was attributable to proceeds from the exercise of common stock options and the purchase of common stock under our employee stock plans.
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;
· Facilities, equipment and IT systems required to support current and future operations:
· 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;
· Effect of competing technological and market developments;
· Number and timing of acquisitions and other strategic transactions;
· Costs and resources required for successful integration of TomoTherapy; and
· Upon the closing of the acquisition, we will be able to utilize the cash held by TomoTherapy.
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 financing may not be available at all, or in amounts or on terms acceptable to us. If we are unable to obtain this additional financing, we may be required to reduce the scope of our planned product development and marketing efforts.
Contractual Obligations and Commitments
We presented our contractual obligations in our Annual Report on Form 10-K for the previous annual reporting period ended June 30, 2010. There have been no material changes in those obligations during the current quarter, other than the entering into the definitive agreement relating to the proposed Transaction.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations is based on our condensed consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these condensed consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, as well as revenue and expenses during the reporting periods. We evaluate our estimates and judgments on an ongoing basis. We base our estimates on historical experience and on various other factors we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities. Actual results could therefore differ materially from those estimates if actual conditions differ from our assumptions.
All of our significant accounting policies and methods used in the preparation of our condensed consolidated financial statements are described in Note 2, Summary of Significant Accounting Policies, in Notes to the condensed consolidated financial statements. The methods, estimates and judgments that we use in applying our accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates regarding matters that are inherently uncertain. Management believes the critical accounting policies and estimates are those related to revenue recognition, inventory valuation, stock-based compensation, income taxes, legal and other contingencies and corporate bonus accruals.
Revenue Recognition
We frequently enter into sales arrangements with customers that contain multiple elements or deliverables such as hardware, software and services. In order to comply with GAAP, we have to make a number of reasoned judgments with respect to elements of these sales arrangements, including how to allocate the proceeds received from an arrangement, whether there are multiple elements of the arrangement, whether any undelivered elements are essential to the functionality of the delivered elements and the appropriate timing of revenue recognition with respect to these arrangements. For revenue arrangements with multiple elements which were entered into by June 30, 2010 and which have not subsequently been materially modified, we allocate arrangement consideration to each element based upon vendor specific objective evidence, or VSOE, of fair value of the respective elements. VSOE of fair value for each element is based upon our historical standard rates charged for the product or service when such product or service is sold
separately or based upon the price established by our management-comprised pricing committee, which has the relevant authority when that product or service is not yet sold separately. Changes to the elements in an arrangement and the ability to establish VSOE of the fair value for those elements could affect the timing and the amount of revenue recognition.
In the first quarter of fiscal 2011, we adopted Accounting Standards Update, or ASU, 2009-13, Multiple-Deliverable Revenue Arrangements (amendments to Accounting Standards Codification, or ASC, Topic 605, Revenue Recognition), or ASU 2009-13, (formerly Emerging Issues Task Force, or EITF, Issue 08-1) and ASU 2009-14, Certain Arrangements That Include Software Elements (amendments to Financial Accounting Standards Board, or FASB, ASC Topic 985, Software), or ASU 2009-14 (formerly EITF 09-3). The new standard changes the requirements for establishing separate units of accounting in a multiple element arrangement and requires the allocation of arrangement consideration to each deliverable to be based on the relative selling price. The FASB also amended the accounting standards for revenue recognition to exclude software that is contained in a tangible product from the scope of software revenue guidance if the software is essential to the tangible products functionality. We adopted these new standards on a prospective basis; therefore, they apply only to revenue arrangements entered into or materially modified beginning July 1, 2010. The revised guidance primarily provides two significant changes: 1) it requires us to allocate revenues in an arrangement using best estimated selling prices, or BESP, of deliverables if we do not have VSOE or third-party evidence, or TPE, of selling price; and 2) it eliminates the residual method and requires us to allocate revenue using the relative selling price method. The BESP is established considering multiple factors including, but not limited to, pricing practices, internal costs, geographies and gross margin. The determination of BESP is made through consultation with and formal approval by our pricing committee, taking into consideration the overall go-to-market pricing strategy. We may modify or develop new go-to-market practices in the future. As these go-to-market strategies evolve, we may modify our pricing practices in the future, which may result in changes in selling prices, impacting both VSOE and BESP. These factors may result in a different allocation of revenue to the deliverables in multiple element arrangements from the current fiscal year, which may change the pattern and timing of revenue recognition for these elements but will not change the total revenue recognized for the arrangement.
Revenue recognition also depends on all or a combination of the timing of shipment, completion of installation, customer acceptance and the readiness of customers facilities. If shipments are not made on scheduled timelines, installation schedules are delayed or if the products are not accepted by the customer in a timely manner, our reported revenues may differ materially from expectations.
Examples of the impact of these factors include the following. If the shipment of a CyberKnife system sold for $4.0 million was delayed, system revenue would be lowered by this $4.0 million, less any amounts deferred for service, training, or other future deliverables. If a CyberKnife system was sold for $4.0 million and the sale involved multiple elements including training and service, a 5% change in BESP of the system would result in an insignificant impact to the amount of revenue allocated and recognized as product revenue rather than as service revenue.
Inventories
The valuation of inventory requires us to estimate obsolete or excess inventory as well as damaged inventory. The determination of obsolete or excess inventory requires us to estimate the future demand for our products. We regularly review inventory quantities on hand and adjust for excess and obsolete inventory based primarily on historical usage rates and our estimates of product demand to support future sales and service. If our demand forecast for specific products is greater than actual demand and we fail to reduce purchasing and manufacturing output accordingly, we could be required to write off inventory, which would negatively impact our gross margin. For example, if the actual amount of inventory that is disposed of as obsolete, excess or damaged is 10% larger or smaller than the amount that we estimated at June 30, 2010, then we would need to increase or decrease cost of sales by approximately $0.3 million.
Stock-Based Compensation Expense
We use the Black-Scholes option valuation model to estimate the fair value of stock options and Employee Stock Purchase Plan shares. The Black-Scholes model requires the input of highly subjective assumptions. The most significant assumptions are our estimates of the expected volatility and the expected term of the award. Our expected volatility is derived from the historical volatilities of several unrelated public companies within industries related to our business because we do not have sufficient trading history on our common stock. When making the selections of our peer companies within industries related to our business to be used in the volatility calculation, we also considered the stage of development, size and financial leverage of potential comparable companies. In addition, as our historical share option exercise experience as a publicly-held entity does not provide a reasonable basis upon which to estimate the expected term, we estimate the expected term of options granted by taking the average of the vesting term and the contractual term of the option, as illustrated by the simplified method. The assumptions used in calculating the fair value of share-based payment awards represent managements best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future.
We recognize compensation cost for only those shares expected to vest over the requisite service period of the award. We estimate our forfeiture rate based on an analysis of our actual forfeitures and will continue to evaluate the appropriateness of the forfeiture rate based on recent forfeiture activity and expected future employee turnover. Quarterly changes in the estimated forfeiture rate can have a significant effect on reported stock-based compensation expense, as the cumulative effect of adjusting the rate for all expense amortization is recognized in the period the forfeiture estimate is changed. If a revised forfeiture rate is higher than the previously estimated forfeiture rate, an adjustment is made that will result in a decrease to the stock-based compensation expense recognized in the consolidated financial statements. If a revised forfeiture rate is lower than the previously estimated forfeiture rate, an adjustment is made that will result in an increase to the stock-based compensation expense recognized in the consolidated financial statements. During the third quarter of fiscal year 2011, a change to our estimated forfeiture rate by five percentage points would result in an insignificant increase or decrease in overall stock-based compensation expense.
Income Taxes
We calculate our current and deferred tax provisions based on estimates and assumptions that could differ from the actual results reflected in our income tax returns filed during the subsequent year. We record adjustments based on filed returns when we have identified and finalized them, which is generally in the third quarter of the subsequent year for U.S. federal and state provisions, respectively. We have placed a full valuation allowance on all net U.S. deferred tax assets because realization of these tax benefits through future taxable income cannot be reasonably assured. We intend to maintain the valuation allowance until sufficient positive evidence exists to support the reversal of the valuation allowance. Any decision to reverse part or all of the valuation allowance would be based on our estimate of future profitability. If our estimate were to be wrong we could be required to charge potentially significant amounts to income tax expense to establish a new valuation allowance.
Our effective tax rate includes the impact of certain undistributed foreign earnings for which we have not provided U.S. taxes because we plan to reinvest such earnings indefinitely outside the United States. We plan foreign earnings remittance amounts based on projected cash flow needs as well as the working capital and long-term investment requirements of our foreign subsidiaries and our domestic operations. Material changes in our estimates of cash, working capital and long-term investment requirements in the various jurisdictions in which we do business could impact our effective tax rate. We are subject to income taxes in the United States and certain foreign countries, and we are subject to corporate income tax audits in some of these jurisdictions. We believe that our tax return positions are fully supported, but tax authorities are likely to challenge certain positions, which may not be fully sustained. However, our income tax expense includes amounts intended to satisfy income tax assessments that result from these challenges. Determining the income tax expense for these potential assessments and recording the related assets and liabilities requires management judgments and estimates. We evaluate our uncertain tax positions in accordance with the guidance for accounting for uncertainty in income taxes. We believe that our reserve for uncertain tax positions is adequate. We review our reserves quarterly, and we may adjust such reserves because of proposed assessments by tax authorities, changes in facts and circumstances, issuance of new regulations or new case law, previously unavailable information obtained during the course of an examination, negotiations between tax authorities of different countries concerning our transfer prices, or the expiration of statutes of limitations.
Loss Contingencies
As discussed in Note 7, Contingencies, in Notes to condensed consolidated financial statements above, we are involved in various lawsuits, claims and proceedings that arise in the ordinary course of business. We record a provision for a liability when we believe that it is both probable that a liability has been incurred and the amount can be reasonably estimated. Significant judgment is required to determine both probability and the estimated amount. We review these provisions at least quarterly and adjust these provisions to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and updated information. Currently, we do not have a potential liability related to any current legal proceedings and claims that would individually or in the aggregate materially adversely affect our financial condition or operating results. Litigation is inherently unpredictable and is subject to significant uncertainties, some of which are beyond our control. Should any of these estimates and assumptions change or prove to have been incorrect, we could incur significant charges related to legal matters which could have a material impact on our results of operations, financial position and cash flows.
Corporate Bonus Expense and Accruals
We record accruals for estimated corporate bonus expense which is paid out in the first quarter of the subsequent fiscal year. Our expense accruals are based on our forecasted results for three factors: net revenue, pre-tax operating income and orders to backlog. If we underestimate or overestimate any of these factors during a fiscal year, adjustments to bonus expense and accruals may be necessary in subsequent periods during the year. For example, if our actual results as of the end of a fiscal year yielded a bonus attainment that varied by 5% from our prior estimate, we would need to increase or decrease our bonus expense accrual in the fourth quarter of the fiscal year by approximately $0.2 million. Historically, our estimated accrued liabilities have approximated actual expense incurred.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
At March 31, 2011, we had $57.3 million of cash and cash equivalents and $85.6 million invested in other financial instruments. Our earnings on interest income generated from our cash and investment balances are affected by changes in interest rates. We believe that while the instruments we hold are subject to changes in the financial standing of the issuer of such securities, and except as described below, we are not subject to any material risks arising from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices or other market changes that affect market risk sensitive instruments. However, should interest rates increase, the market value of our investments may decline, which could result in a realized loss if we are forced to sell before their scheduled maturity. If overall interest rates had risen by 100 basis points, the fair value of our net investment position at March 31, 2011 would have decreased by approximately $0.3 million, assuming consistent levels of investments.
Foreign Currency Exchange Rate Risk
As of March 31, 2011, there were no amounts in deferred revenue for sales contracts for CyberKnife system denominated in a foreign currency in which system revenue will be recognized in future periods. Future fluctuations in the value of the U.S. dollar may affect the price competitiveness of our products outside the United States. For direct sales outside the United States, it is likely we will sell in the local currency, which could expose us to additional foreign currency risks, including changes in currency exchange rates. Some of our commissions related to sales of the CyberKnife system are payable in Euros. To the extent that management can predict the timing of payments under these contracts that are denominated in foreign currencies, we may engage in hedging transactions to mitigate such risks in the future.
Item 4. Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and in reaching a reasonable level of assurance, management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As of March 31, 2011, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of March 31, 2011 our disclosure controls and procedures were effective such that the information relating to our Company, including our consolidated subsidiaries, required to be disclosed in our SEC reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the three months ended March 31, 2011. We note that effective January 1, 2011, we converted to a new Enterprise Resource Planning, or ERP, system, Microsoft AX, to help manage our business, to process transactions, and to record financial activity. We have adapted our processes and procedures to reflect our use of this new ERP system which is an integral element of our internal control over financial reporting. Based on the evaluation described above, our Chief Executive Officer and Chief Financial Officer concluded that there has not been any change in our internal control over financial reporting during the three months ended March 31, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitations of Internal Controls
Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.
Please refer to Note 7 to the condensed consolidated financial statements above for a description of certain legal proceedings currently pending against our Company. From time to time we are involved in legal proceedings arising in the ordinary course of our business.
Set forth below and elsewhere in this report and in other documents we file with the SEC are descriptions of the risks and uncertainties that could cause our actual results to differ materially from the results contemplated by the forward-looking statements contained in this report. The descriptions below include any material changes to and supersede the descriptions of the risk factors affecting our business previously disclosed in Part I, Item IA. Risk Factors of our Annual Report on Form 10-K for the fiscal year ended June 30, 2010 and our Quarterly Reports on Form 10-Q for the fiscal quarters ended September 30, 2010 and December 31, 2010. We also refer you to the Risk Factors contained in our Registration Statement on Form S-4 filed with the SEC on April 7, 2011, as amended, declared effective on May 6, 2011.
Risks Related to the Merger Agreement
Combining our business with TomoTherapy may be more difficult, costly or time-consuming than expected, which may adversely affect our results of operations and adversely affect the value of our common stock following the merger.
We have entered into the merger agreement because we believe that the merger will be beneficial to our company and our stockholders. The success of the merger will depend, in part, on our and TomoTherapys ability to realize the anticipated benefits from combining our businesses. To realize these anticipated benefits, we must successfully combine our businesses in an efficient and effective manner. If we are not able to achieve these objectives within the anticipated time frame, or at all, the anticipated benefits and cost savings of the merger may not be realized fully, or at all, or may take longer to realize than expected, and the value of our common stock may be adversely affected.
We and TomoTherapy have operated and, until the completion of the merger, will continue to operate, independently. It is possible that the integration process could result in the loss of key employees, the disruption of each companys ongoing business or inconsistencies in standards, controls, procedures and policies that adversely affect our or TomoTherapys ability to maintain relationships with customers, employees, suppliers and other business partners following the merger or to achieve the anticipated benefits of the merger. Specifically, issues that must be addressed in integrating the operations of TomoTherapy into our operations in order to realize the anticipated benefits of the merger include, among other things:
· integrating and optimizing the utilization of the properties, equipment, suppliers, distribution channels, manufacturing, marketing, promotion and sales activities and information technologies of TomoTherapy and us;
· consolidating corporate and administrative infrastructures of TomoTherapy and us;
· coordinating geographically dispersed organizations of TomoTherapy and us;
· retaining existing customers and attracting new customers of TomoTherapy and us; and
· conforming standards, controls, procedures and policies, business cultures and compensation structures between the companies.
Integration efforts between the two companies will also divert management attention and resources. An inability to realize the full extent of the anticipated benefits of the merger, as well as any delays encountered in the integration process, could have an adverse effect upon our results of operations, which may affect adversely the value of our common stock after the completion of the merger.
In addition, the actual integration may result in additional and unforeseen expenses, and the anticipated benefits of the integration plan may not be realized. Actual synergies, if achieved at all, may be lower than what we expect and may take longer to achieve than anticipated. If we are not able to adequately address these challenges, we may be unable to successfully integrate TomoTherapys operations into our own or to realize the anticipated benefits of the integration of the two companies.
Any delay in completing the merger may substantially reduce the benefits that we expect to obtain from the merger.
The merger is subject to a number of conditions beyond our control that may prevent, delay or otherwise materially adversely affect its completion. There can be no assurance that all approvals will be obtained nor that all conditions will be satisfied. We cannot predict whether or when the conditions required to complete the merger will be satisfied. The requirements for obtaining the required clearances and approvals could delay the Effective Time for a significant period of time or prevent it from occurring at all. Moreover, we and TomoTherapy may terminate the merger agreement if the merger is not consummated by September 30, 2011, or, in certain circumstances, by October 31, 2011. Any delay in completing the merger may materially adversely affect the synergies and other benefits that we expect to achieve if the merger and the integration of the companies respective businesses are completed within the expected timeframe.
Uncertainties associated with the merger may cause a loss of employees and may otherwise affect our future business and operations.
Our success after the merger will depend in part upon our ability to retain our and TomoTherapys key employees. Prior to the merger, our and TomoTherapys employees may experience uncertainty about their roles with the Company following the merger. Employees of TomoTherapy who we retain following the merger may also experience similar uncertainty after the completion of the merger. This may adversely affect the ability of each of TomoTherapy and us to attract or retain key management, sales, technical and other personnel. Key employees of TomoTherapy and the Company may depart because of issues relating to the uncertainty and difficulty of integration or a desire not to remain with us following the merger. As a result, we may not be able to attract or retain key employees of the Company and TomoTherapy following the merger to the same extent that we and TomoTherapy have been able to attract or retain our and their own employees in the past, which could have a negative impact on our business following the merger. If key employees depart, the integration of the companies may be more difficult, and our business following the merger could be materially harmed.
The market price of our common stock after the merger may be affected by factors different from those affecting the shares of our common stock prior to the merger.
Our and TomoTherapys businesses differ in many respects including product offerings and relationships with customers and suppliers, and accordingly, our results of operations following the merger and the market price of shares of our common stock after the merger may be affected by factors different from those currently affecting our results of operations.
We will incur significant costs in connection with the merger.
We expect to incur approximately $8.0 million of out-of-pocket costs associated with the merger, consisting primarily of financial, legal and accounting fees and expenses. Through the quarter ended March 31, 2011, we have incurred approximately $2.6 million related to the merger. Similarly, TomoTherapy expects to incur approximately $7.0 million of out-of-pocket costs associated with the merger, consisting primarily of financial, legal and accounting fees and expenses. We also expect to incur non-recurring costs associated with combining the operations of the two companies. Most of these costs will be comprised of facilities and systems consolidation costs and employment-related costs. We will also incur fees and costs related to formulating integration plans. Additional unanticipated costs may be incurred in the integration of the companies businesses. Although we expect that the elimination of duplicative costs, as well as the realization of other efficiencies related to the integration of the businesses, should allow us to offset incremental transaction and merger-related costs over time, this net benefit may not be achieved in the near term, or at all.
The merger may not be accretive and may cause dilution to our earnings per share, which may negatively affect the market price of our common stock.
We currently anticipate that the merger will be accretive to our earnings per share (on an adjusted earnings basis) in our fiscal year beginning July 1, 2012. This expectation is based on preliminary estimates, which may change materially. We may also encounter additional transaction-related costs or other factors such as the failure to realize all of the benefits anticipated in the merger. All of these factors could cause dilution to our earnings per share or decrease or delay the expected accretive effect of the merger and cause a decrease in the market price of our common stock.
If the merger is completed, we may not be able to realize all of the desired benefits from TomoTherapys relationship with Compact Particle Acceleration Corporation (CPAC).
Since April 2008, TomoTherapy has been an investor in CPAC to continue development of its research initiative for a compact proton therapy system for the treatment of cancer. CPAC has and is continuing to seek investments from third parties to support the development of this technology. TomoTherapy currently has the option to purchase a portion of the CPAC stock held by CPAC investors in exchange for the right to commercialize the technology in the medical field, and it has the right to exercise this option at any time through April 2015. After the merger, although we will have the rights of TomoTherapy under its agreements with
CPAC, we may not be able to obtain all of the potential benefits relating to CPAC that we may desire. In addition, CPAC needs additional funding to continue its development efforts. We cannot be certain that CPAC will be able to obtain all of the additional financing required for this project on commercially reasonable terms or that the technology development will be successful. Even if CPAC is able to obtain financing and the technology development is successful, CPAC may not have the resources to commercialize the compact proton system, the market requirements may change such that commercialization is no longer feasible, or we may not be in a position to finance the option to purchase a portion of the CPAC stock held by CPAC investors in exchange for the right to commercialize the technology in the medical field.
Our stock price may be adversely affected if the merger is not completed.
Completion of the merger is subject to certain closing conditions, including, among others, obtaining requisite regulatory approvals and the approval of TomoTherapys shareholders. We and TomoTherapy may be unable to obtain such approvals on a timely basis or at all. Other closing conditions may not be satisfied. If the merger is not completed, the prices of our common stock may decline to the extent that the current market price of our common stock reflects a market assumption that the merger will be completed and to the extent that our business is adversely affected if the merger is not completed.
Our business may be adversely affected if the merger is not completed.
If the merger is not completed, our ongoing business may be adversely affected and we will be subject to several risks and consequences, including the following:
· We will be required to pay certain costs incurred by TomoTherapy relating to the merger, whether or not the merger is completed;
· Under the merger agreement, we are subject to certain restrictions on the conduct of our business prior to completing the merger which may adversely affect our ability to execute certain of our business strategies; and
· Matters relating to the merger may require substantial commitments of time and resources by our management, which could otherwise have been devoted to other opportunities that may have been beneficial to us as an independent company, as the case may be.
In addition, there may be uncertainty surrounding the future direction of our business and strategy on a standalone basis, and we may experience negative reactions from the financial markets and from our employees, customers, suppliers and other business partners. We could be subject to litigation related to any failure to complete the merger, or to enforcement proceedings commenced against us to perform our obligations under the merger agreement. If the merger is not completed, we cannot assure our stockholders that the risks described above will not materialize and will not materially adversely affect our business, financial condition, results of operations and stock price. Moreover, as we dedicate resources and attention to the merger and subsequent integration, our competitors may exploit the opportunity to improve the position of their businesses and gain market share.
We must obtain regulatory approvals to complete the merger, which, if delayed, not granted or granted with unacceptable conditions, may jeopardize or postpone the completion of the merger, result in additional expenditures of money and resources, reduce the anticipated benefits of the merger or adversely affect the our stock price.
Completion of the merger is subject to obtaining requisite regulatory approvals. We may be unable to obtain such approvals on a timely basis or at all, or such approvals may be obtained only with unacceptable conditions or costs. This may jeopardize or postpone the completion of the merger, result in additional expenditures of money and resources, reduce the benefits of the merger that we currently anticipate, or adversely affect our stock price.
Lawsuits have been filed against TomoTherapy and the members of the TomoTherapy board of directors challenging the merger, and an adverse judgment or ruling in any lawsuit challenging the merger may prevent the merger from being completed within the expected timeframe, or at all.
TomoTherapy and the members of the TomoTherapy board of directors are parties to several lawsuits filed by third parties seeking equitable relief, including an injunction against the merger, and costs and expenses of the litigation, including attorneys fees, in connection with the merger agreement. The defendants consider the complaints to be without merit and intend to vigorously defend against them.
One of the conditions to the closing of the merger is the absence of any law, temporary restraining order, injunction, judgment, order or decree issued by any governmental entity that prohibits or makes illegal the consummation of the merger. As such, if the plaintiffs are successful in obtaining an injunction prohibiting TomoTherapy from consummating the merger on the agreed-upon terms, then such injunction may prevent the merger from being completed within the expected timeframe, or at all.
If the merger is completed, the combined company may not be able to achieve profitability with respect to TomoTherapys service business.
TomoTherapys overall service operations currently are not profitable. The combined companys ability to increase the profitability of TomoTherapys service business depends in part on reducing warranty and service costs for the TomoTherapy treatment systems and improving economies of scale in service operations. The combined company may be unable to achieve these reductions in costs or improve the reliability of TomoTherapys systems during the time period expected or at all, and this could result in the combined companys inability to realize some of the benefits TomoTherapy and Accuray anticipate from the merger.
If the merger is completed, certain factors may adversely affect the combined companys ability to fully utilize TomoTherapys tax loss carryforwards.
TomoTherapy has reported that, as of December 31, 2010, it had $96.3 million of U.S. federal net operating loss carryforwards, which will expire beginning in 2021, and $66.5 million of state net operating loss carryforwards, which will expire beginning in 2013. There can be no assurance that all of TomoTherapys net operating loss carryforwards will be available to offset future taxable income of the combined company. In addition, it is possible that utilization of the net operating loss carryforwards will be subject to a substantial annual limitation due to limitations under the Internal Revenue Code and similar state provisions arising from ownership changes.
The financial results of the combined company may materially differ from the pro forma financial information presented in the Registration Statement on Form S-4 we filed with the SEC on April 7, 2011, as amended, declared effective on May 6, 2011.
The historical pro forma financial information presented in the Registration Statement on form S-4 we filed with the SEC on April 7, 2011, as amended, declared effective on May 6, 2011, reflects the estimates, assumptions and judgments made by management of the Company and TomoTherapy. These estimates, assumptions and judgments have affected the reported amounts of assets and liabilities as of the dates presented as well as revenue and expenses reported for the periods presented. The resolution of differences between the two companies accounting policies and methods, including estimates, assumptions and judgments, may result in materially different financial information than is presented in the pro forma financial statements.
We and TomoTherapy use different criteria to determine backlog, and accordingly, the backlog of the combined company may be less than the sum of each companys backlog at the time of the merger, which may adversely affect the market price of shares of Accuray common stock.
We and TomoTherapy currently use different criteria to determine our backlog. Changes in the criteria used to determine backlog may result in the combined companys reported backlog being materially different from the sum of each companys previously reported backlog. If the amount of reported backlog of the combined company is less than the sum of each companys previously reported backlog, the market price of our common stock following the merger may be adversely affected.
We may pursue other strategic transactions in the future, which could be difficult to implement, disrupt our business or change our business profile significantly.
We will continue to consider potential strategic transactions, which could involve acquisitions or dispositions of businesses or assets. Any future strategic transaction could involve numerous risks, including:
· potential disruption of our ongoing business and distraction of management;
· difficulty integrating acquired businesses or segregating assets to be disposed of;
· exposure to unknown, contingent or other liabilities, including litigation arising in connection with the acquisition or disposition against any businesses we may acquire; and
· changing our business profile in ways that could have unintended consequences.
If we enter into significant strategic transactions in the future, related accounting charges may adversely affect our financial condition and results of operations, particularly in the case of any acquisitions. In addition, the financing of any significant acquisition may result in changes in its capital structure, including the incurrence of additional indebtedness and the dilution of our existing stockholders ownership.
Risks Related to Our Business
If the CyberKnife system does not achieve widespread market acceptance, we will not be able to generate the revenue necessary to support our business.
Achieving physician, patient, hospital administrator and third-party payor acceptance of the CyberKnife system as a preferred method of tumor treatment will be crucial to our continued success. Physicians will not begin to use or increase the use of the CyberKnife system unless they determine, based on experience, clinical data and other factors, that the CyberKnife system is a safe and effective alternative to current treatment methods. We often need to educate physicians about the use of stereotactic radiosurgery, convince healthcare payors that the benefits of the CyberKnife system and its related treatment process outweigh its costs and help train qualified physicians in the skilled use of the CyberKnife system. For example, the complexity and dynamic nature of stereotactic radiosurgery and Robotic IMRT requires significant education of hospital personnel and physicians regarding the benefits of stereotactic radiosurgery and Robotic IMRT and require departures from their customary practices. We have expended and will continue to expend significant resources on marketing and educational efforts to create awareness of stereotactic radiosurgery and Robotic IMRT generally and to encourage the acceptance and adoption of our products for these technologies.
The CyberKnife system was initially used primarily for the treatment of tumors in the brain, and the broader use of the system to treat tumors elsewhere in the body has been a more recent development. As a result, physician and patient acceptance of the CyberKnife system as a comprehensive tool for treatment of solid tumor cancers anywhere in the body has not yet been fully demonstrated, particularly as compared to products, systems or technologies that have longer histories in the marketplace. The CyberKnife system is a major capital purchase and purchase decisions are greatly influenced by hospital administrators who are subject to increasing pressures to reduce costs. These and other factors, including the following, may affect the rate and level of the CyberKnife systems market acceptance:
· The CyberKnife systems price relative to other products or competing treatments;
· Our ability to develop new products and enhancements and receive regulatory clearances and approval, if required, to existing products in a timely manner;
· Effectiveness of our sales and marketing efforts;
· The impact of the current economic environment on our business, including the postponement by our customers of purchase decisions or required build-outs;
· Capital equipment budgets of healthcare institutions;
· Increased scrutiny by state boards when evaluating certificates of need requested by purchasing institutions;
· Perception by physicians and other members of the healthcare community of the CyberKnife systems safety, efficacy and benefits compared to competing technologies or treatments;
· Publication in peer-reviewed medical journals of data regarding the successful use and longer term clinical benefits of the CyberKnife system;
· Willingness of physicians to adopt new techniques and the ability of physicians to acquire the skills necessary to operate the CyberKnife system;
· Extent of third-party coverage and reimbursement rates, particularly from Medicare, for procedures using the CyberKnife system;
· Development of new products and technologies by our competitors or new treatment alternatives;
· Regulatory developments related to manufacturing, marketing and selling the CyberKnife system both within and outside the United States;
· Perceived liability risks arising from the use of new products; and
· Unfavorable publicity concerning the CyberKnife system or radiation-based treatment alternatives.
If the CyberKnife system is unable to achieve or maintain market acceptance, our revenue levels would decrease and our business would be harmed.
If we are unable to develop new products or enhance existing products, we may be unable to attract or retain customers.
Our success depends on the successful development, regulatory clearance or approval, introduction and commercialization of new generations of products, treatment systems, and enhancements to and/or simplification of existing products. The CyberKnife system is technologically complex and must keep pace with, among other things, the products of our competitors. We are making significant investments in long-term growth initiatives. For example, in November of 2009 we announced the introduction of the CyberKnife VSI system, which allows physicians to perform conventionally fractioned robotic intensity modulated radiation therapy, or Robotic IMRT, in addition to stereotactic radiosurgery. Such initiatives require significant capital commitments, involvement of senior management and other investments on our part, which we may be unable to recover. Our timeline for the development of new products or enhancements may not be achieved and price and profitability targets may not prove feasible. Commercialization of new products may prove challenging, and we may be required to invest more time and money than expected to successfully introduce them. Once introduced, new products may adversely impact orders and sales of our existing products, or make them less desirable or even obsolete. Compliance with regulations, competitive alternatives, and shifting market preferences may also impact the successful implementation of new products or enhancements.
Our ability to successfully develop and introduce new products, treatment systems and product enhancements and simplifications, and the revenues and costs associated with these efforts, are affected by our ability to:
· Properly identify customer needs;
· Prove feasibility of new products;
· Educate physicians about the use of new products and procedures;
· Limit the time required from proof of feasibility to routine production;
· Comply with internal quality assurance systems and processes timely and efficiently;
· Limit the timing and cost of obtaining regulatory approvals or clearances;
· Accurately predict and control costs associated with inventory overruns caused by phase-in of new products and phase-out of old products;
· Price our products competitively;
· Manufacture and deliver our products in sufficient volumes on time, and accurately predict and control costs associated with manufacturing, installation, warranty and maintenance of the products;
· Manage customer acceptance and payment for products;
· Manage customer demands for retrofits of both old and new products; and
· Anticipate and compete successfully with competitors.
Even if customers accept new products or product enhancements, the revenues from these products may not be sufficient to offset the significant costs associated with making them available to customers.
We cannot be sure that we will be able to successfully develop, obtain regulatory approval or clearance, manufacture or introduce new products, treatment systems or enhancements, the roll-out of which involves compliance with complex quality assurance processes, including the quality system regulation, or QSR, enforced by the FDA. Failure to complete these processes timely and efficiently could result in delays that could affect our ability to attract and retain customers, or could cause customers to delay or cancel orders, causing our backlog, revenues and operating results to suffer.
We may face numerous risks in connection with our strategic alliance with Siemens AG, any of which could cause our expected revenues to be harmed if they were to be realized.
In June 2010, we entered into a Strategic Alliance Agreement with Siemens AG, or the Alliance Agreement, pursuant to which (1) we granted Siemens certain distribution rights to our CyberKnife systems, (2) Siemens agreed to incorporate certain Accuray technology into certain of its linear accelerator products, the combined products being known as the Cayman Products, and (3) we created a research and development relationship between Accuray and Siemens for the pursuit and implementation of other
potential collaboration opportunities in the future. During the quarter ended December 31, 2010, Siemens reorganized its Healthcare division. To date we and Siemens have not yet agreed on the definition of a specification for the first Cayman Product as originally anticipated, therefore little development work and no milestone payments have occurred. We have had discussions with the new management within Siemens Healthcare regarding this project and they have indicated that they are reviewing their plans and considering the potential impact of our announced agreement to acquire TomoTherapy. There can be no assurance that the strategic alliance with Siemens AG will be successful or that the economic terms of the Alliance Agreement will ultimately prove to be favorable to us. We are not able to control the amount and timing of resources that Siemens will devote to the development, sales or marketing of the Cayman Products, the distribution of CyberKnife systems, or to future collaboration opportunities. Our own business may be disrupted, and we may have to divert attention from our other research and development activities, in order to satisfy our obligations under the Alliance Agreement. We may incur costs in excess of the consideration to be paid to us by Siemens. Even if Siemens and the Company successfully complete development of a product, it may not receive the regulatory approvals necessary to be marketed and sold. Failure to successfully develop, market and sell the product, failure of Siemens to distribute the CyberKnife system, and the failure of Accuray and Siemens to successfully collaborate on future opportunities could negatively impact our stock price and our future business and financial results.
Disruption of critical information systems could harm our business and financial condition.
Information technology helps us operate efficiently, interface with customers, maintain financial accuracy and efficiency, and accurately produce our financial statements. We implemented and began use of a new ERP system effective January 1, 2011. Our initial implementation covered the basic elements of our ERP system. We plan to implement additional capabilities in the future. If we do not allocate and effectively manage the resources necessary to build and sustain the proper technology infrastructure, or if we fail to smoothly manage the new ERP system, we could be subject to transaction errors, processing inefficiencies, the loss of customers, business disruptions, or the loss of or damage to intellectual property through security breach. If our data management systems do not effectively collect, store, process and report relevant data for the operation of our business, whether due to equipment malfunction or constraints, software deficiencies, or human error, our ability to effectively plan, forecast and execute our business plan and comply with applicable laws and regulations will be impaired, perhaps materially. Any such impairment could materially and adversely affect our financial condition, results of operations, cash flows and the timeliness with which we report our internal and external operating results.
If we are unable to provide the significant education and training required for the healthcare market to accept our products, our business will suffer.
In order to achieve market acceptance of the CyberKnife system, we often need to educate physicians about the use of stereotactic radiosurgery, convince healthcare payors that the benefits of the CyberKnife system and its related treatment process outweigh its costs and help train qualified physicians in the skilled use of the CyberKnife system. For example, the complexity and dynamic nature of stereotactic radiosurgery and Robotic IMRT requires significant education of hospital personnel and physicians regarding the benefits of stereotactic radiosurgery and Robotic IMRT and require departures from their customary practices. We have expended and will continue to expend significant resources on marketing and educational efforts to create awareness of stereotactic radiosurgery and Robotic IMRT and to encourage the acceptance and adoption of our products for these technologies. We cannot be sure that any products we develop will gain significant market acceptance among physicians, patients and healthcare payors, even if we spend significant time and expense on their education. Failure to gain significant market acceptance would adversely affect our product sales and revenues, harming our business, financial condition and results of operations.
We have a large accumulated deficit, may incur future losses and may be unable to maintain profitability.
As of March 31, 2011, we had an accumulated deficit of $119.4 million. We may incur net losses in the future, particularly as we increase our manufacturing, research and development, and marketing activities in connection with, among other things, the Strategic Alliance Agreement we entered into with Siemens AG on June 8, 2010. Our ability to 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. We cannot assure you that we will be able to maintain profitability. In the event we fail to maintain profitability, our stock price could decline.
We face risks related to the current global economic environment, which could delay or prevent our customers from obtaining financing to purchase the CyberKnife system and implement the required facilities, which would adversely affect our business, financial condition and results of operations.
The state of the global economy continues to be somewhat uncertain. The current global economic conditions pose a risk to the overall economy that could impact consumer and customer demand for our products, as well as our ability to manage normal commercial relationships with our customers, suppliers and creditors, including financial institutions. If the current situation deteriorates or does not improve, our business could be negatively affected, including such areas as reduced demand for our products resulting from a slow-down in the general economy, supplier or customer disruptions and/or temporary interruptions in our ability to
conduct day-to-day transactions through our financial intermediaries involving the payment to or collection of funds from our customers, vendors and suppliers.
In addition, due to tight credit markets and concerns regarding the availability of credit, particularly in the United States, some of our customers have been delayed in obtaining, or have not been able to obtain, necessary financing for their purchases of the CyberKnife system or for the construction or renovation of facilities to house CyberKnife systems, the cost of which can range from approximately $0.5 million, for a customer who makes only minor renovations to an existing facility, to approximately $2.5 million, for a customer who builds an entirely new facility that includes additional features not necessarily required for the operation of a CyberKnife system (e.g., audio visual equipment). This range is based solely on information provided to us by customers and will vary by geography and the needs of particular customer. To date, these delays have primarily affected customers that were planning to operate freestanding CyberKnife systems centers, rather than hospital-based customers. These delays have in some instances led to our customers postponing the shipment and installation of previously ordered systems or cancelling their system orders, and may cause other customers to postpone their system installation or to cancel their agreements with us. An increase in delays and order cancellations of this nature would adversely affect our product sales and revenues, and therefore harm our business and results of operations.
The high unit price of the CyberKnife system, as well as other factors, may contribute to substantial fluctuations in our operating results, which could adversely affect our stock price.
Because of the high unit price of the CyberKnife system and the relatively small number of units installed each quarter, each installation of a CyberKnife system can represent a significant percentage of our revenue for a particular quarter. Therefore, if we do not install a CyberKnife system when anticipated, our operating results will vary significantly from our expectations. This is of particular concern in the current volatile economic environment, where we have had experiences with customers cancelling or postponing orders for our CyberKnife system and delaying the required build-outs. These fluctuations and other potential fluctuations mean that you should not rely upon our operating results in any particular period as an indication of future performance. In particular, in addition to the other factors described in this Part II, Item 1A, factors which may contribute to these fluctuations include:
· Timing of and ability to complete the merger with TomoTherapy;
· Timing of when we are able to recognize revenue associated with sales of the CyberKnife system, which varies depending upon the terms of the applicable sales and service contracts;
· The proportion of revenue attributable to purchases of the CyberKnife system, our shared ownership program and installations, which is associated with our legacy service plans;
· Timing and level of expenditures associated with new product development activities;
· Regulatory requirements in some states for a certificate of need prior to the installation of a radiation device;
· Delays in shipment due, for example, to unanticipated construction delays at customer locations where our products are to be installed, cancellations by customers, natural disasters or labor disturbances;
· Delays in our manufacturing processes or unexpected manufacturing difficulties;
· Timing of the announcement, introduction and delivery of new products or product upgrades by us and by our competitors;
· Timing and level of expenditures associated with expansion of sales and marketing activities such as trade shows and our overall operations;
· Fluctuations in our gross margins and the factors that contribute to such fluctuations, as described in the Managements Discussion and Analysis Results of Operations;
· How well we execute on our strategic and operating plans;
· The extent to which our products gain market acceptance;
· Actions relating to regulatory matters;
· Demand for our products;
· Our ability to develop, introduce and market new or enhanced versions of our products on a timely basis;
· Our ability to protect our proprietary rights and defend against third party challenges;
· Disruptions in the supply or changes in the costs of raw materials, labor, product components or transportation services; and
· Changes in third party coverage and reimbursement, changes in government regulation, or a change in a customers financial condition or ability to obtain financing.
These factors are difficult to forecast and may contribute to substantial fluctuations in our quarterly revenues and substantial variation from our projections, particularly during the periods in which our sales volume is low. These fluctuations may cause volatility in our stock price.
Because the majority of our revenue is derived from sales of the CyberKnife system, and because we experience a long and variable sales and installation cycle, our quarterly results may be inconsistent from period to period. These fluctuations in revenue may make it difficult to predict our revenue.
Our primary product is the CyberKnife system. Unless the merger with TomoTherapy is consummated, we expect to generate substantially all of our revenue for the foreseeable future from sales of and service contracts for the CyberKnife system. The CyberKnife system has lengthy sales and purchase order cycles because it is a major capital equipment item and requires the approval of senior management at purchasing institutions. The sales process in the United States typically begins with pre-selling activity followed by sales presentations and other sales-related activities. After the customer has expressed an intention to purchase a CyberKnife system, we negotiate and enter into a definitive purchase contract with the customer. Typically, following the execution of the contract, the customer begins the building or renovation of a facility to house the CyberKnife system, which together with the subsequent installation of the CyberKnife system, can take up to 24 months to complete. During the period prior to installation, the customer must build a radiation-shielded facility to house its CyberKnife system. In order to construct this facility, the customer must typically obtain radiation device installation permits, which are granted by state and local government bodies, each of which may have different criteria for permit issuance. If a permit were denied for installation at a specific hospital or treatment center, our CyberKnife system could not be installed at that location. In addition, some of our customers are cancer centers or facilities that are new, and in these cases it may be necessary for the entire facility to be completed before the CyberKnife system can be installed, which can result in additional construction and installation delays. Our sales and installations of CyberKnife systems tend to be heaviest during the third month of each fiscal quarter.
Under our revenue recognition policy, we generally do not recognize revenue attributable to a CyberKnife system purchase until after installation has occurred, if we are responsible for providing installation, or delivery. For international sales through distributors, we typically recognize revenue when the system is shipped with evidence of sell through to the end user. Under our current forms of purchase and service contracts, we receive a majority of the purchase price for the CyberKnife system upon installation or delivery of the system. Events beyond our control may delay installation and the satisfaction of contingencies required to receive cash inflows and recognize revenue, such as:
· Procurement delay;
· Customer funding or financing delay;
· Delay in or unforeseen difficulties related to customers organizing legal entities and obtaining financing for CyberKnife system acquisition;
· Construction delay;
· Delay pending customer receipt of regulatory approvals, including, for example, certificates of need;
· Delay pending customer receipt of a building or radiation device installation permit; and
· Delay caused by weather or natural disaster.
In the event that a customer does not, for any of the reasons above or other reasons, proceed with installation of the system after entering into a purchase contract, we would only recognize up to the deposit portion of the purchase price as revenue, unless the deposit was refunded to the customer. Therefore, the long sales cycle together with delays in the shipment and installation of CyberKnife systems or customer cancellations would adversely affect our cash flows and revenue, which would harm our results of
operations and may result in significant fluctuations in our reporting of quarterly revenues. Because of these fluctuations, it is likely that in some future quarters, our operating results will fall below the expectations of securities analysts or investors. If that happens, the market price of our stock would likely decrease. These fluctuations also mean that you will not be able to rely upon our operating results in any particular period as an indication of future performance.
Our ability to increase our profitability depends in part on maintaining or increasing our gross margins on product sales and service, which we may not be able to achieve.
A number of factors may result in adverse impacts to our gross margins, including:
· The timing of revenue recognition and revenue deferrals;
· Sales discounts;
· Changes in product configurations;
· Increases in material or labor costs;
· Increased service costs;
· Increased warranty costs;
· Excess inventory and inventory holding charges;
· Obsolescence charges;
· Our ability to reduce production costs;
· Increased price competition;
· Variation in the margins across products installed in a particular period; and
· How well we execute on our strategic and operating plans.
If third-party payors do not provide sufficient coverage and reimbursement to healthcare providers for use of the CyberKnife system, demand for our products and our revenue could be adversely affected.
Our customers rely significantly on reimbursement for CyberKnife procedures. Our ability to commercialize our products successfully will depend in significant part on the extent to which public and private third-party payors provide adequate coverage and reimbursement for procedures that are performed with our products. Third party payors, and in particular managed care organizations, challenge the prices charged for medical products and services and institute cost containment measures to control or significantly influence the purchase of medical products and services. If reimbursement policies or other cost containment measures are instituted in a manner that significantly reduces the coverage for or payment for our procedures that are performed with our products, our existing customers may not continue using our products or may decrease their use of our products, and we may have difficulty obtaining new customers. Such actions would likely have a material adverse effect on our operating results. In November 2010, the centers for Medicare and Medicaid Services, or CMS, issued the 2011 Medicare payment rates. Certain of the reimbursement rates are modestly lower than in the prior year, which could have a negative impact on the continued use of our products by existing customers and our ability to obtain new customers. CMS reviews such rates annually, and could implement more significant changes in future years. If in the future CMS significantly decreases reimbursement rates for stereotactic radiosurgery and Robotic IMRT services, or if other cost containment measures are implemented in the United States or elsewhere, such changes could discourage cancer treatment centers and hospitals from purchasing our products. We have seen our customers decision making process complicated by the uncertainty surrounding the proposed reduction in Medicare reimbursement rates for radiotherapy and radiosurgery at freestanding clinics in the United States and for physician reimbursement for radiation oncology, which has resulted in delay and sometimes even failure to purchase our products.