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| VAR > SEC Filings for VAR > Form 10-K on 24-Nov-2008 | All Recent SEC Filings |
24-Nov-2008
Annual Report
Overview
In fiscal year 2008, total revenues from continuing operations grew 18% and net orders from continuing operations rose 15% over fiscal year 2007 results. Both of our business segments contributed to the increases in revenues and net orders. Compared to the prior fiscal year, Oncology Systems revenues in fiscal year 2008 increased 16% and net orders increased 14%. The significant growth in the flat panel detector product line drove X-ray Products revenues and net orders to increase 19% and 24%, respectively, over the prior fiscal year. Revenues in our "Other" businesses rose 62% in fiscal year 2008 over the year-ago period, while net orders declined 7%. Backlog at the end of fiscal year 2008 rose 14% from the end of fiscal year 2007 to $1.9 billion.
Net earnings from continuing operations per diluted share increased 24% to $2.31 in fiscal year 2008 from $1.86 in fiscal year 2007, with net earnings from continuing operations increasing 22% to $295 million in fiscal year 2008 from $243 million in fiscal year 2007. In the fourth quarter of fiscal year 2008, we approved a plan to sell Research Instruments in order to focus exclusively on the development of our ACCEL Proton Therapy business. Accordingly, Research Instruments is classified as a discontinued operation for all periods presented and we have segregated the net assets and operating results of Research Instruments from continuing operations on our Consolidated Balance Sheets and in our Consolidated Statement of Earnings. Unless otherwise stated, the discussion herein pertains to our continuing operations. Research Instruments was previously included in the "Other" category. The Research Instruments business reduced total net earnings per diluted share by $0.12 for fiscal year 2008 to $2.19.
Oncology Systems. Our largest business segment is Oncology Systems, which designs, manufacturers, sells and services hardware and software products for radiation treatment of cancer with conventional radiation therapy, IMRT, IGRT, stereotactic radiotherapy and stereotactic radiosurgery, brachytherapy and VMAT.
Oncology Systems net orders grew in fiscal year 2008 over fiscal year 2007 primarily driven by demand for our new RapidArc radiotherapy products since their introduction in the second quarter of fiscal year 2008. We also experienced growth in demand in both the North American and the international regions for our high energy linear accelerators and our service contracts. Growth in demand for our accessory products that enable IGRT (including our OBI) primarily in the international region also contributed. A weaker U.S. dollar against foreign currencies in fiscal year 2008 compared to fiscal year 2007 also contributed to the international net order growth between the fiscal years.
In fiscal year 2008, we experienced strong demand for our new RapidArc products, with more than 300 orders booked in the year. We believe RapidArc will contribute to the growth in our Oncology Systems revenues in fiscal year 2009. Most of the orders for RapidArc came from North America, where early adopters are typically concentrated. We believe RapidArc represents a significant advancement in IMRT cancer treatment and can help drive longer term demand for our linear accelerators and our IMRT-related accessory products.
Customers are also recognizing IGRT and stereotactic radiosurgery as significant enhancements in curative radiation therapy. We believe treatments using IGRT technology are becoming widely accepted in radiation therapy and radiosurgery, with North America ahead of international regions in the timing of IGRT adoption. About 80% of worldwide orders taken for our high energy linear accelerators during fiscal year 2008 included our OBI. Through September 26, 2008, we had shipped more than 1,000 units of OBI for our high-energy linear accelerators.
We believe regional fluctuations in demand are consistent with an observed historical pattern where the international regions follow North America in the adoption of new technology. We are also experiencing faster early adoption rates for our RapidArc products and IGRT products than historical adoption rates for our other products, which may lead to more compressed growth cycles. As was the case in fiscal year
2008, we believe that growth in our net orders, revenues and gross margin may also be influenced by the fluctuation of exchange rates of the U.S. dollar against foreign currencies. The weakening U.S. dollar that we have experienced over the last several years has made our pricing more competitive with our foreign competitors, which has been a contributor to our international order and revenue growth. The strengthening of the U.S. dollar against other foreign currencies may make our pricing less competitive and result in slower growth in our international orders and revenues, which then could negatively affect our overall financial performance and results. Additionally, we have seen the purchasing cycle lengthen for some customers, which we believe results from a more complex decision-making process associated with larger dollar value transactions for more sophisticated IGRT and surgical equipment and other technical advances. Revenues are also influenced by the timing of product shipments which are tied to planned customer-requested delivery dates. These factors may result in greater fluctuation in our Oncology Systems net orders and revenues.
Our success in Oncology Systems largely depends upon our ability to retain leadership in technological innovation, the reliability and cost effectiveness of our products, the efficacy of our treatment technology and external economic influences. Factors affecting the adoption rate of new technologies such as IGRT and VMAT could include their more-widely demonstrated efficacy and acceptance of these technologies and our internal efficiency in design, documentation and testing, and deployment and installation of our new technologies and products. Additional factors could include customer training on the use of our new technologies or related products and our ability to educate customers about the cost effectiveness of our new technologies and clinical outcome advantages. External economic influences could include financial strength of our customers, the availability of credit to our customers, consolidation among our customers, currency exchange rates, significant changes to Medicare and Medicaid reimbursement rates for radiotherapy and brachytherapy procedures and radiosurgery in the United States, government budgeting and tendering cycles and governmental healthcare policies. The general worldwide economic downturn we have seen in 2008 may make it difficult for our customers, our vendors and us to accurately forecast and plan future business activities. A customer's decision-making process may be further complicated as the current worldwide economic turmoil causes hospitals, clinics and research institutions to more closely scrutinize and prioritize their capital spending budgets. We cannot predict the timing or duration of any economic slowdown or the timing or strength of a subsequent economic recovery, in general or specifically in the healthcare industry. If the healthcare market significantly deteriorates due to these macroeconomic effects, our business, financial condition and results of operations will likely be materially and adversely affected.
X-Ray Products. Our X-ray Products business segment manufactures and sells
(i) x-ray tubes for use in a range of applications including computed
tomography, or CT, scanning, radiographic or fluoroscopic imaging, mammography,
special procedures and industrial applications and (ii) flat panel digital image
detectors for filmless x-ray imaging (commonly referred to as flat panel
detectors or digital image detectors), which are an alternative to image
intensifier tubes for fluoroscopy and x-ray film and computed radiography, or
CR, systems for radiography.
X-ray Products growth in net orders and revenues in fiscal year 2008 over fiscal year 2007 was primarily due to strong growth in our flat panel detector product line which we believe will continue to contribute to our growth as flat panel detectors, which enable filmless x-ray, replace traditional film and image-intensifier x-ray products in many medical applications. Rising costs of raw materials due to increased worldwide demand, which we have seen over the last two years, continued to affect the X-ray Products business through most of fiscal year 2008, though we have recently seen decreases in some commodity prices for our materials as the economic downturn has become more worldwide and global demand for such commodities have lessened. In December 2007, we acquired Pan-Pacific, an independent distributor of medical x-ray tubes and other imaging components in China, for approximately $2.0 million, plus an additional contingent "earn out" payment of up to $3.5 million. Pan-Pacific enhances the sales channel for x-ray tubes and flat panel products in China.
Our success in our X-ray Products business depends upon our ability to anticipate changes in our markets, the direction of technological innovation and the demands of our customers. Factors affecting the success of our X-ray Products business include our ability to develop products with lower cost, better quality and superior technology and performance, and to maintain strong relationships with our OEM customers. The general worldwide economic downturn we have seen in 2008 may make it difficult for our OEM customers, our vendors and us to accurately forecast and plan future business activities. If the markets for our customers significantly deteriorate due to these macroeconomic effects, our business and results of operations may be adversely affected.
Other. The "Other" category is comprised of Security and Inspection Products, or SIP (including Bio-Imaging Research, Inc., or BIR, which we acquired in the third quarter of fiscal year 2007), the ACCEL Proton Therapy business, and the operations of the Ginzton Technology Center, or GTC.
SIP designs, manufactures, sells and services Linatron® x-ray accelerators, imaging processing software and image detection products for security and inspection purposes, such as cargo screening at ports and borders and nondestructive examination for a variety of applications.
We are now seeing wider deployment of our Linatron x-ray accelerators for cargo screening and border protection as customers are placing orders for multiple units. While we are optimistic about SIP's long-term potential and encouraged by the increased interest in our SIP products, use of this technology in security cargo screening and border protection is still in its early stages. Orders and revenues for our SIP products may be unpredictable as governmental agencies may place large orders with our OEM customers in a short time period and then may not place any orders for a long time period thereafter. In April 2008, we added a new manufacturing facility for the production of SIP products in Las Vegas.
Our ACCEL Proton Therapy business develops, designs, manufactures and services products and systems for delivering proton therapy, another form of external beam radiation therapy using proton beams for the treatment of cancer. Proton therapy, as a clinical treatment modality, is still not wide-spread and the technology is still developing. We are investing substantial resources to commercialize ACCEL's advanced proton technology and to build this new business. Proton therapy facilities, nevertheless, are large scale construction projects that can take three years or more to complete. With the cost of a multiple-gantry system in excess of $60 million and the total cost for a center approaching $100 million, significant customer investment and perhaps complex project financing will be required. Consequently, the customers' decision-making cycle is very long and orders for proton therapy systems generally involve many contingencies. Since we currently will not book these orders until contingencies are eliminated, we do not expect to book any orders for proton therapy systems in the short term and do not expect to start generating significant proton therapy systems revenues until fiscal year 2010 at the earliest. Given the heavy reliance of customers of this business on credit and large-scale project financing, this business may be the most vulnerable to general economic turmoil and contraction in the credit markets.
GTC, our scientific research facility, continues to invest in developing technologies that enhance our current businesses or may lead to new business areas, including next generation digital x-ray imaging technology, volumetric and functional imaging, and improved x-ray sources and technology for security and cargo screening applications. In addition, GTC is developing technologies and products that are designed to improve disease management by more precise targeting of radiation, as well as by employing targeted energy and molecular agents to enhance the effectiveness and broaden the application of radiation therapy.
Compared to fiscal year 2007, net orders in the "Other" category were down 7% in fiscal year 2008 due primarily to a reduction in the proton therapy service business. Revenue grew by 62% in fiscal year 2008 over the year-ago period due to growth in SIP product revenues.
This discussion and analysis of our financial condition and results of operations is based upon and should be read in conjunction with the Consolidated Financial Statements and the notes included elsewhere in this Annual Report on Form 10-K, as well as the information contained under "Risk Factors contained in Item 1A. We discuss our results of operations below.
Critical Accounting Estimates
The preparation of our financial statements and related disclosures in conformity with accounting principles generally accepted in the United States, or GAAP, requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates and assumptions are based on historical experience and on various other factors that we believe are reasonable under the circumstances. We periodically review our accounting policies and estimates and make adjustments when facts and circumstances dictate. In addition to the accounting policies that are more fully described in the Notes to the Consolidated Financial Statements included in this Annual Report on Form 10-K, we consider the critical accounting policies described below to be affected by critical accounting estimates. Our critical accounting policies that are affected by accounting estimates include share-based compensation expense, revenue recognition, valuation of allowance for doubtful accounts, valuation of inventories, assessment of recoverability of goodwill and intangible assets, valuation of warranty obligations, assessment of environmental remediation liabilities, valuation of defined benefit and post-retirement benefit plans and taxes on earnings. Such accounting policies are impacted significantly by judgments, assumptions and estimates used in the preparation of our Consolidated Financial Statements, and actual results could differ materially from these estimates. For a discussion of how these estimates and other factors may affect our business, also refer to the Risk Factors in Item 1A.
Share-based Compensation Expense
Effective October 1, 2005, we adopted Statement of Financial Accounting Standards, or SFAS, No. 123 (revised 2004), Share-Based Payment, or SFAS 123(R), using the modified prospective transition method. We have valued our share-based payment awards granted beginning in fiscal year 2006 using the Black-Scholes option-pricing model. The determination of fair value of share-based payment awards on the date of grant using the Black-Scholes option-pricing model is affected by VMS's stock price, as well as the input of other subjective assumptions, including the expected term of stock awards and the expected price volatility of VMS stock over the expected term of the awards.
The expected term is based on the observed and expected time to post-vesting exercise and post-vesting cancellations of stock options by our employees. Upon the adoption of SFAS 123(R), we determined the expected term of stock options based on the demographic grouping of employees and retirement eligibility. Upon the adoption of SFAS 123(R), we used a combination of historical and implied volatility, or blended volatility, in deriving the expected volatility assumption. Blended volatility represents the weighted average of implied volatility and historical volatility. Implied volatility was derived based on six-month traded options on VMS common stock. Implied volatility is weighted in the calculation of blended volatility based on the ratio of the six-month term of the exchange-traded options to the expected lives of the employee stock options. Historical volatility represents the remainder of the weighting. Our decision to incorporate implied volatility was based on our assessment that implied volatility of publicly traded options in VMS common stock is reflective of market conditions and is generally reflective of both historical volatility and expectations of how future volatility will differ from historical volatility. In determining the extent of use of implied volatility, we considered: (i) the volume of market activity of traded options; (ii) the ability to reasonably match the input variables of traded options to those of stock options granted by us, including the date of grant; (iii) the similarity of the exercise prices; and (iv) the length of term of traded options. After considering the above factors, we determined that we cannot rely exclusively on implied volatility based on the fact that the term of VMS six-month exchange-traded options is less than one year and that it is different from the expected lives of the stock options we granted. Therefore, we believe a combination of the historical volatility over the expected lives of the stock options granted by us and the implied volatility of six-month exchange-traded options best reflects the expected volatility of VMS common stock going forward. The risk-free interest rate assumption is based upon observed interest rates appropriate for the term of our stock options. The dividend yield assumption is based on our history and expectation of dividend payouts. If factors change
and we employ different assumptions in the application of SFAS 123(R) in future periods, the compensation expense that we record under SFAS 123(R) may differ significantly from what we have recorded in the current period. In addition, we are required to estimate the expected forfeiture rate and recognize expense only for those shares expected to vest. If our actual forfeiture rate is materially different from our estimate, the stock-based compensation expense could be significantly different from what we have recorded in the current period.
Revenue Recognition
We frequently enter into sales arrangements with customers that contain multiple elements or deliverables such as hardware, software and services. Judgments as to the allocation of the proceeds received from an arrangement to the multiple elements of the arrangement, the determination of whether any undelivered elements are essential to the functionality of the delivered elements and the appropriate timing of revenue recognition are critical in respect to these arrangements to ensure compliance with GAAP. In addition, the amount of product revenues recognized is affected by our judgments as to whether objective and reliable evidence of fair value exists for hardware products and vendor-specific objective evidence of the fair value for software products in arrangements with multiple elements. Changes to the elements in an arrangement and the ability to establish objective and reliable evidence of fair value or vendor-specific objective evidence of the fair value for those elements could affect the timing of revenue recognition. Revenue recognition also depends on the timing of shipment and is subject to customer acceptance and the readiness of customers' facilities. If shipments are not made on scheduled timelines or if the products are not accepted by the customer in a timely manner, our reported revenues may differ materially from expectations. In addition, revenues related to certain highly customized scientific research instrument products and proton therapy commissioning service contracts, as well as highly customized image detection systems, are recognized under the percentage of completion method. Under the percentage-of-completion method of accounting, sales and gross profit are recognized as work is performed based on the relationship between actual costs incurred and total estimated costs at the completion of the contract. If a loss is expected on a contract, the estimated loss would be charged to cost of sales in the period the loss is identified. Because the percentage-of-completion method involves considerable use of estimates in determining revenues, costs and profits and in assigning the amounts to accounting periods, and because the estimates must be periodically reviewed and appropriately adjusted, if our estimates prove to be inaccurate, we may be forced to adjust revenues or even record a contract loss in later periods.
Allowance for Doubtful Accounts
Credit evaluations are undertaken for all major sale transactions before shipment is authorized. Normal payment terms usually require payment of a small portion of the total amount due upon signing of the purchase order, a significant amount upon transfer of risk of loss and the remaining amount upon completion of the installation. On a quarterly basis, we evaluate aged items in the accounts receivable aging report and provide an allowance in an amount we deem adequate for doubtful accounts. If our evaluation of our customers' financial conditions does not reflect the future ability to collect outstanding receivables, additional provisions may be needed and our operating results could be negatively impacted.
Inventories
Our inventories include high technology parts and components that are specialized in nature or subject to rapid technological obsolescence. We have programs to minimize the required inventories on hand and 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 and production. Actual demand may differ from our estimates, in which case we may have understated or overstated the provision required for obsolete and excess inventory, which would have an impact on our operating results.
Goodwill and Intangible Assets
Goodwill is initially recorded when the purchase price paid for a business acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. The majority of companies that we have acquired have not had significant identified tangible assets and, as a result, a significant portion of the purchase price has been typically allocated to intangible assets and goodwill. Our future operating performance will be impacted by the future amortization of these acquired intangible assets and potential impairment charges related to goodwill if indicators of impairment exist. As a result of business acquisitions, the allocation of the purchase price to goodwill and intangible assets could have a significant impact on our future operating results. The allocation of the purchase price of the acquired companies to goodwill and intangible assets requires us to make significant estimates and assumptions, including estimates of future cash flows expected to be generated by the acquired assets and the appropriate discount rate for these cash flows. Should conditions differ from management's estimates at the time of the acquisition, material write-downs of intangible assets and/or goodwill may be required, which would adversely affect our operating results.
We annually evaluate goodwill and purchased assets with indefinite lives for impairment in accordance with SFAS 142 "Goodwill and Other Intangible Assets." The impairment test for goodwill is a two-step process. Step one consists of a comparison of the fair value of a reporting unit with its carrying amount, including the goodwill allocated to each reporting unit. We determine the fair value of our reporting units based on the present value of estimated future cash flows of the reporting units. If the carrying amount is in excess of the fair value, step two requires the comparison of the implied fair value of the reporting unit's goodwill with the carrying amount of the reporting unit's goodwill. Any excess of the carrying value of the reporting unit's goodwill over the implied fair value of the reporting unit's goodwill is recorded as an impairment loss. The impairment test for intangible assets with indefinite useful lives, if any, consists of a comparison of fair value to carrying value, with any excess of carrying value over fair value being recorded as an impairment loss. We will continue to make assessments of impairment on an annual basis in the fourth quarter of our fiscal years or more frequently if indicators of potential impairment arise.
Warranty Obligations
We warrant most of our products for a specific period of time, usually twelve months, against material defects. We provide for the estimated future costs of warranty obligations in cost of revenues when the related revenues are recognized. The accrued warranty costs represent our best estimate at the time of sale of the total costs that we will incur to repair or replace product parts that fail while still under warranty. The amount of accrued estimated warranty costs obligation for established products is primarily based on historical experience as to product failures adjusted for current information on repair costs. For new products, estimates will include historical experience of similar products, as well as reasonable allowance for start-up expenses. Actual warranty costs could differ from the estimated amounts. On a quarterly basis, we review the accrued balances of our warranty obligations and update the historical warranty cost trends, if required. If we were required to accrue additional warranty costs in the future, it would negatively impact our operating results.
Environmental Matters
We are subject to a variety of environmental laws around the world regulating the handling, storage, transport and disposal of hazardous substances that do or may create increased costs for some of our operations. Environmental remediation liabilities are recorded when environmental assessments and/or remediation efforts are probable and the costs of these assessments or remediation efforts can be reasonably estimated, in accordance with SFAS No. 5, Accounting for Contingencies, and the American Institute of Certified Public Accountants, Statement of Position 96-1, Environmental Remediation Liabilities. The accrued environmental costs represent our best estimate as to the total costs of remediation and the time period over which these costs will be incurred. On a quarterly basis, we review
these accrued balances. If we were required to accrue additional environmental remediation costs in the future, it would negatively impact our operating results.
Defined Benefit and Post-Retirement Benefit Plans
We sponsor six defined benefit pension plans in Germany, Japan, Switzerland and the United Kingdom covering the employees who meet the applicable eligibility . . .
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