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VRAY: Solid Q2, FY2018 Guidance Intact. New CEO Outlines Vision for Growth

By Brian Marckx, CFA



Q2 Results: Solid Q2, FY2018 Guidance Intact. New CEO Outlines Vision for Growth

ViewRay (NASDAQ:VRAY) announced financial results for their second quarter 2018 and provided a business update. In terms of the financials, revenue was well-ahead of our (pre-preannounced Q2) numbers, reflecting one earlier-than-estimated installation (3 A vs 2 E), partially offset by slightly softer than modeled (~15%) average pricing. Both of these differences should dissipate through the end of the year, with management continuing to guide for FY2018 total revenue of $80M - $90M (i.e. inline with our prior and current estimate) and expectations that average ASP, which was somewhat diluted in Q2 due to preferred pricing on a first-in-territory (in China) system installation, firms up.

One of the major highlights on the operational front was changes at some of the top leadership positions - including CEO and COO. While not something that we had anticipated, we think the changes may provide a fresh perspective on how best to grow the company. Certainly that seems to be consistent with comments on the Q2 call by Scott Drake, the newly appointed CEO. Mr. Drake comes with substantive experience in med-tech and what looks to be an overall fairly well-fit background, including as CEO of Spectranetics Corp, a cardiovascular device manufacturer. Impressively, Spectranetics' enterprise value grew 10x under Drake's tutelage until being acquired by Royal Philips in 2017 for over $2B. Scott Drake also assumes the President position as well as a board seat.

Shar Matin was hired as VRAY's COO. He held the same position at Spectranetics' (2014 - acq). And finally, Keith Grossman, joins VRAY's board. Grossman's background, which includes extensive leadership experience in med-tech, also looks like a very good fit for VRAY.

Product and total revenue were $15.4M and $16.4M in Q2, compared to $0/$698k in Q2 '17 and $25.4M/$26.2M in Q1 '18. Product revenue reflected installation of three new MRIdian systems at an ASP of approximately $5.1M. We look for another three installations in Q3 and four in Q4 - and for ASP in 2H '18 to increase in the high single digit percentages as compared to Q2. Our FY2018 revenue estimate remains largely unchanged at $88.8M.

Product margin, at just 5% in Q2, was negatively impacted by write-off (of $2.7M) of Cobalt-related inventory. Excluding that non-recurring charge, product margin would have been approximately 22% (inline with our 23% estimate). Gross margin was 0% but, again, would have been much healthier if not for the inventory charge. While we think there's potential for future q-to-q volatility in margins (particularly in times and in instances when preferred pricing makes strategic sense) we expect GM to continue to grow over the longer-term. Importantly, with expectations of volume-related economies of scale and other efficiencies, management continues to guide for gross margins to approach 30% by current year-end and 40% in 2019.

Operating expenses ticked up on both a yoy and qoq basis. At least a portion of that appears to be related to some headcount additions. We expect operating expenses will continue to trend higher over time as additional resources are brought into the sales/marketing functions and as VRAY expands new product development. But, on percentage if sales basis, we think opex contracts as sales grow and results in greater operating leverage. And, coupled with expanding product margins, we think operating loss begins to improve in 2019.

Cash position was $66M at Q2 quarter-end. VRAY used $11.4M and $48.8M ($17.3M and $27.6M, ex-changes in working capital) in cash for operating activities in the three and six months ending 6/30/18, compared to $11.9M and $23.9M ($12.2M and $22.9M, ex-changes in working capital) in the comparable prior year periods. The company used a total $73M of cash in 2017 and is now guiding for total cash usage of $90M - $100M in 2018.

Business Update:
As of June 30th, 17 MRIdian systems (7 Cobalt-60 and 10 Linac) have been installed at 15 cancer centers, including eight in the U.S. and seven OUS. VRAY’s backlog remains robust. While some relatively old orders slipped off the backlog during Q2, that was more than offset by the value of new orders which came online. VRAY ended Q2 with a backlog of $200M, up from $195M at the close of Q1 '18 and $182M at the end of Q2 '17.

During Q2 VRAY received new MRIdian orders of more than $34M. Importantly, management continues to guide for full-year revenue in the range of $80M to $90M (implying yoy growth of at least 135%), representing an anticipated 13 to 15 system. With seven installations made through the first six months of the year, this implies another six to eight will occur by the end of 2018.

VRAY has wind at their back following a strong ending to 2017 and a similarly rapid start to 2018. Certain catalysts should either make an initial impact or more significant impact during 2018. This includes Shonin approval for the MRIdian Linac system, which came in March, clearing it for marketing in Japan. Japan is one of the world’s largest medical device markets. VRAY, which already has two Cobalt systems in the country (including one at the National Cancer Center), has collaborated with ITOCHU Corporation as their Japan-based representative for commercialization. JASTRO (Japan Society of Radiation Oncology) in October should be another awareness-building opportunity for VRAY.

New Linac system installations in leading research institutions and cancer centers in Europe, the U.S. and Japan as well as continued participation at key industry conferences should also significantly benefit awareness-building efforts. A key French tender was among the latest sales-related highlights. The tender, announced in July, is from UNICANCER, a 19-hospital network and currently includes three systems - with potentially more to follow.

Another milestone of-sorts was set in July when the first community hospital in the U.S. installed a MRIdian Linac system. The installation at Palos Health South Campus in Orland Park, IL is a significant event for VRAY as community hospitals have been a target focus for the company. The expectation is that this is just the first of many to come.

Leading university and cancer research hospitals have also been a key part of VRAY's expansion strategy. Recent installations in that target market include University Medical Center in Amsterdam, University Clinic Heidelberg in Germany Product and Miami Cancer Institute at Baptist Health. Adoption and use of MRIdian among high profile cancer centers should undoubtedly facilitate VRAY's awareness building efforts and further validate the superiority of the technology. VRAY also recently announced that the University of Wisconsin Carbone Cancer Center (Madison) and Washington University School of Medicine (St. Louis) began treating with their first and second MRIdian Linac systems, respectively.

In terms of industry events, MRIdian was featured in 55 abstracts selected for presentation at AAPM (July 29 - August 2). VRAY's pipeline, represent additional potential catalysts to growth, was also highlighted - including SmartVISION, which improves tissue visualization and is available in Europe (and for which 510(k) FDA clearance has been filed). The AAPM presentations follow 16 presentations and posters in which MRIdian was featured at ESTRO in April. Other awareness-building events this year included a day-long global symposium at VU Medical Center which was attended by 200 oncology experts and which featured several speakers including those with experience with MRIdian.

A regular flow of clinical data could be particularly key in driving uptake of MRIdian. Lower radiation exposure, improved cosmetic outcomes, lower recurrence rates and overall better patient outcomes are examples of potentially potent endpoints that could facilitate steepening adoption of MRIdian. As the MRIdian installed base expands and utilization and clinical experience grows, so should the opportunity for more evidence-based studies.

Installation times are expected to continue to shorten, which further facilitate growth in product revenue recognition. Installation time of the MRIdian system has been reduced from about 100 to roughly 60-75 days. Noteworthy is that management mentioned on the Q2 call that the last installation done in Q2 was completed in "well under 60 days" - which may indicate that progress continues towards reducing installation timelines.

While lengthy installation times have been an obstacle, reducing the time to commission the system and increasing installation capacity remain priorities and are something that management expects will continually improve throughout 2018. As the installed base ramps up, we also expect maintenance contracts to increase, which would benefit the firm with a steady stream of recurring revenue.

Changing of the guard brings updated strategy…
In addition to reducing installation timelines, Scott Drake outlined his key priorities for accelerating growth of the company. Those include providing necessary resources to sales and marketing, continual focus on innovation to remain in front of the competition and to expand the clinical evidence portfolio of MRIdian.

We use a 10-year DCF model to value ViewRay Inc. The majority of our revenue forecast for the out years are based on the sales of the MRIdian-Linac system since we expect RT to transition towards this technology globally. We expect revenue to continue to ramp through 2H 2018. We currently model total revenue of $89M in 2018 and $146M in 2019. We think, perhaps conservatively, that VRAY can reach a level of sales of $750M by the year 2028, the new out-year in our 10-year DCF model. Inclusion of 2028 as the new out-year in our 10-year DCF, which also incorporates a 10% discount rate and 2% terminal growth rate, has moved our price target to $12.50/share. Our outlook is subject to change depending on the progress with expanding installed base and regulatory approvals.

See above for free access to our updated report on VRAY which includes our financial model and outlook.

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