I attended Accuray's (ARAY) annual shareholder meeting on November 20, 2009. The Palo Alto, California law firm of Wilson Sonsini Goodrich & Rosati hosted the meeting. The law firm provided coffee, orange juice, pastries, and fruit for shareholders.
Accuray sells "CyberKnife," which is used to remove tumors. CyberKnife allows doctors to remove tumors using non-invasive radiation instead of traditional surgery. According to the company, CyberKnife is a "robotic radiosurgical system [that uses] high doses of precisely delivered radiation to destroy tumors anywhere in the body where radiation is indicated."
Over 70,000 patients have been treated with the CyberKnife system, mostly for tumors outside the brain (although brain tumors account for approximately 40% of CyberKnife treatments). Because CyberKnife is a complex product, it requires a large upfront investment from hospitals and/or surgeons. As of September 30, 2009, there were 180 CyberKnife systems installed worldwide, with 117 in the Americas, 20 in Europe, 21 in Japan and 22 in the rest of Asia. A single CyberKnife system costs approximately 4 million dollars. During the meeting, the CEO indicated that in the future, the European Union would be the fastest growing market for Accuray's products.
Accuray's stock performance has been disappointing, and large individual shareholders may feel that the problem is management, not the product. One shareholder, Marilyn Adler, came spoiling for a fight. As the wife of one of the company's founders (Dr. John Adler, Jr.), she began criticizing Accuray's CEO Euan Thomson immediately. She demanded to know why the Board of Directors--absent from this meeting--includes financial experts rather than doctors familiar with cancer research. She accused management of not buying/holding shares because they themselves didn't have confidence in the company (CEO Thomson denied this particular allegation). As he was being subjected to Mrs. Adler's passionate verbal volleys, CEO Euan Thomson appeared as tense as a Buckingham Palace guard. Clutching his glass of water in one hand and a folder in the other hand, CEO Thomson actually got up from his chair during Mrs. Adler's comments, prompting her to say, "I'm not going to let you off so easily."
Afraid the meeting would be over and the CEO would immediately exit the room, I began asking some questions to keep CEO Euan Thomson, General Counsel Darren Milliken (a fellow SCU Law grad), and CFO Derek Bertocci present at the table.
I asked why CyberKnife is more effective than general surgery or other products. The CEO, relieved to get a neutral question, explained that CyberKnife is highly accurate and can better track the patient as s/he moves. Most surgeons use rudimentary tools allowing only a single rotation of radiation treatment, whereas CyberKnife uses a robotic arm with multiple and fluid rotations. Also, CyberKnife’s imaging capabilities do not require the patient to be subjected to an uncomfortable frame. In contrast, if a surgeon wants to use traditional methods to operate in a patient's brain, s/he would typically screw a rigid frame into the patient's skull. This frame would restrict the patient's movement during surgery. The patient would then remain in a fixed position, which limits the angles of treatment and tumor removal techniques. (After reading up on CyberKnife's technology, it struck me that it was something akin to Linux or RedHat--perhaps revolutionary from a technical standpoint, but lacking the broad-based acceptance required to actually cause a revolution in the marketplace.)
I asked the CEO how the amendments to the Stark Law (The Ethics in Patient Referral Act of 1989) would affect his business (see pages 42-44 of the 10K for more information). In a nutshell, the Stark law restricts a physician from referring patients to services or programs in which the physician holds a financial interest. The CEO looked surprised for a second, but General Counsel Milliken immediately jumped in. GC Milliken indicated he believed the Stark Law amendments would not impact sales.
I asked about an unusual line in the 10K, on page 31: "Since the software component is significant in our solution, we are bound by the software revenue recognition rules for our business." I asked what this sentence meant, and whether the company was engaging in accounting gimmicks to boost short-term revenue at the expense of long-term growth. CFO Bertocci said the sentence related to SEC rules on software sales. Basically, it sounds like Accuray must amortize its software sales over several years (spread out its revenue) instead of reporting an immediate lump sum profit when it sells a CyberKnife system. To use a simplistic example, if I buy a business software program for 100 dollars and I intend to use it for five years, I can't deduct the 100 dollars immediately--I have to deduct 20 dollars a year for 5 years, because I plan on using the software for 5 years. However, the CFO also said that sales under the post-2006 CyberKnife contracts allow Accuray to record revenue as soon as the product is "shipped, installed, and accepted" by the customer. I am not an accountant, so I didn't ask how the 2005 contracts differed from the 2006 contracts. As with any company that relies on software sales, I am now concerned Accuray seems able to record short term revenue using methods that might inflate quarterly results. (Note: see the very end of this article for the company's take on the SEC accounting rules.)
I asked why Accuray seemed focused on international markets. CEO Thomson said international markets were growing faster and it was easier to get reimbursed for sales. He said that in the States, hospitals and doctors must negotiate a price with insurance plans each time they use CyberKnife, because Medicare and other insurance plans do not have a pre-set price for a CyberKnife treatment. The CEO indicated the company spends lots of money lobbying Congress to resolve these issues. From my own research, it appears that hospitals may bill each CyberKnife treatment at between 40,000 and 90,000 dollars--obviously a wide range of reimbursement rates.
Ultimately, reimbursement prices and issues should be fixed with time. Medical groups and insurance companies don't want to advocate or reimburse a treatment method unless they are certain it is safe. To analyze whether a treatment is safe, they usually want at least five and sometimes up to fourteen years of data on post-op patients. Due to CyberKnife's relatively new technology and large upfront costs (around 4 million dollars per system), there just haven't been enough patients who've had CyberKnife surgeries to generate a large supply of post-op data. Over time, probably in about seven years, there will be plenty of data showing the effects and efficacy of the CyberKnife product, which should make reimbursement easier if the results are positive.
Based on other comments and questions at the meeting, Accuray is focused on marketing its products through hospitals and physician networks. When questioned about why Accuray didn't use more patient testimonials in advertising, CEO Thomson said he intended to build a "clinical case at hospitals" and didn't want to use patients in a way that would seem "tacky." When Mrs. Adler continued to question the Board of Directors' lack of medical experience, CEO Thomson responded that the Board "is not going to sell" the CyberKnife product.
Mark D., a former CyberKnife patient, made several comments during the meeting. He said he had a good experience with CyberKnife. He believes using CyberKnife instead of traditional cancer treatments caused "fewer secondary effects," such as less radiation-induced nausea. He also indicated CyberKnife treatments could be completed more quickly than traditional cancer treatments, which would save patients money. The fewer treatments needed, the cheaper it can be for the patient, because if s/he lives in a rural area and needs multiple cancer treatments, s/he would have to spend money commuting long distances or staying in a hotel.
Overall, I am conflicted about Accuray shares. On the one hand, I like the product, but I am concerned about reimbursement problems. Insurance companies will probably fight tooth and nail to deny a CyberKnife treatment if a patient can use a cheaper cancer treatment. It saddens me that patients may not be receiving the best treatment possible because of bureaucratic hurdles, but the realist in me understands the situation. I will keep a close eye on Accuray shares and hope to hear good news about the company.
Disclosure: I own an insignificant number of shares of Accuray (ARAY).
Note: prior to publication, I sent my article to Accuray. I have included some of their comments below:
On the SEC software revenue recognition rules: "This rather complex yet conservative accounting approach to revenue recognition applies to older contracts. Per the SEC, Accuray had to defer the recognition of revenue for these legacy agreements until all contractual elements were satisfied. At that point, revenue for the system and service could be ratably recognized over the remaining length of the contract. This is a accounting method used by software companies. While most of this legacy revenue has been recognized, the company will continue to recognize the remaining deferred revenue over the next two years. It is important to note that these contracts stopped being written in 2005, with subsequent contracts subjected to a more standard revenue recognition policy."
On CyberKnife's competitive advantages: "The CK has the ability to track the location of the tumor throughout treatment, with the robot automatically correcting for movement and thereby keeping the radiation beams directed at the tumor. The result is accuracy in the delivery of radiation to the tumor while minimizing the involvement of healthy tissue. Traditional radiation therapy systems are mounted on a gantry, which limits the number of beam angles. Since CK uses a robotic arm with almost unlimited beam angles, the tumor can be 'painted' with radiation beams more effectively. This also helps to spare healthy tissue."
On reimbursement issues: "Throughout most of the country, Medicare and most private insurance companies have set reimbursement rates for CK procedures. There are some exceptions and the company is providing assistance to address these issues."
Bonus: interview with Dr. John Adler, Accuray's founder, HERE.