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| VAR > SEC Filings for VAR > Form 10-Q on 10-Feb-2009 | All Recent SEC Filings |
10-Feb-2009
Quarterly Report
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains "forward-looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995 which provides a "safe harbor" for statements about future events, products and future financial performance that are based on the beliefs of, estimates made by and information currently available to the management of Varian Medical Systems, Inc. ("VMS") and its subsidiaries ("we," "our" or the "Company"). The outcome of the events described in these forward-looking statements is subject to risks and uncertainties. Actual results and the outcome or timing of certain events may differ significantly from those projected in these forward-looking statements or management's current expectations due to the factors cited in this "Management's Discussion and Analysis of Financial Condition and Results of Operations," or MD&A, the Risk Factors listed under Part II, Item 1A of this Quarterly Report on Form 10-Q, and other factors described from time to time in our other filings with the Securities and Exchange Commission, or SEC, or other reasons. For this purpose, statements concerning: industry or market segment outlook; market acceptance of or transition to new products or technology such as fixed field intensity-modulated radiation therapy, or IMRT, image-guided radiation therapy, or IGRT, volumetric modulated arc therapy, or VMAT, brachytherapy, software, treatment techniques, stereotactic radiosurgery, filmless X-rays, security and inspection products, proton therapy products and scientific research instrument products; growth drivers; orders, revenues, backlog or earnings growth; future financial results and any statements using the terms "believe," "expect," "expectation," "anticipate," "can," "should," "will," "would," "could," "estimate," "continue," "grow," "based on," "may," "intended," "potential," "promising," "hope," "optimistic" "on-going," "likely," and "possible" or similar statements are forward-looking statements. By making forward-looking statements, we have not assumed any obligation to, and you should not expect us to, update or revise those statements because of new information, future events or otherwise.
Overview
Net earnings per diluted share was $0.55 in the first quarter of fiscal year 2009, compared to $0.43 in the first quarter of fiscal year 2008. Excluding the discontinued scientific research instruments business, or Research Instruments, of ACCEL Instruments GmbH, or ACCEL, net earnings from continuing operations per diluted share increased to $0.56 in the first quarter of fiscal year 2009 from $0.46 in the first quarter of last fiscal year. Compared to the same period in fiscal year 2008, revenues rose 13% to $509 million and net orders rose 13% to $551 million. Our backlog grew 14% from the end of the year-ago quarter to $1.9 billion as of January 2, 2009.
In the fourth quarter of fiscal year 2008, we approved a plan to sell Research Instruments in order to focus ACCEL 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 in our Condensed Consolidated Balance Sheets and in our Condensed Consolidated Statements of Earnings. Unless otherwise stated, the discussion in this MD&A pertains to our continuing operations. Research Instruments was previously included in the "Other" category.
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, which is a special form of IMRT. Products include linear accelerators, brachytherapy afterloaders, treatment simulation and verification equipment and accessories; as well as information management, treatment planning and image processing software.
In our view, the fundamental market drivers for long-term growth in radiation therapy, stereotactic radiosurgery and brachytherapy continue to be the rising cancer incidence; technology advances and product developments that are leading to improvements in patient care; customer demand for more advanced, effective and comfortable cancer treatments, such as IMRT, IGRT, stereotactic radiosurgery, brachytherapy and VMAT; competitive conditions among hospitals and clinics to offer such advanced treatments; improvement in cost efficiency in delivering radiation therapy; and underserved medical needs outside of the United States. Our primary goal in the Oncology Systems business segment is to promote the adoption of more advanced and effective cancer treatments.
Our new RapidArcTM radiotherapy products are a proprietary implementation of VMAT to control the beam shape, dose rate and gantry speed in a concerted manner to deliver a highly conformal dose distribution to the target tumor in a single continuous rotation, rather than as a series of fixed fields. These products enable planning and delivering an image-guided
IMRT treatment in a single revolution of the radiation treatment beam around the patient for a quicker delivery of treatment. As of the end of the first quarter of fiscal year 2009, we had more than 425 orders for our RapidArc products and received customer acceptance for more than 70 installations of our RapidArc products since we introduced these products in the second quarter of fiscal year 2008. We believe RapidArc represents a significant advancement in IMRT cancer treatment and can help drive longer term demand for our linear accelerators, our IMRT-related accessory products.
For the first quarter of fiscal year 2009, Oncology Systems reported growth in net orders of 11%, with a 6% growth in North America and a 16% growth in the international region. Geographically, Asia led the growth in Oncology Systems net orders. Oncology Systems North American revenues in the first quarter of fiscal year 2009 grew 43% over the first quarter of fiscal year 2008, when Oncology Systems North American remained relatively flat with the first quarter of fiscal year 2007. Oncology Systems international revenues declined by 18% in the first quarter of fiscal year 2009 over the first quarter of fiscal year 2008, when international revenues grew by 28% over the first quarter of fiscal year 2007. Compared to the prior year quarter, Oncology Systems gross margin improved by 0.8 percentage points in the first quarter of fiscal year 2009, primarily because North American revenues, which typically have higher gross margins than international revenues, represented a higher proportion of total revenues, as well as because higher margin products (including our RapidArc products), represented a higher proportion of total product revenues. These improvements in product gross margins were partially offset by a decline in service contract gross margin.
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 made our pricing more competitive with our foreign competitors, and contributed to our international order and revenue growth. The strengthening of the U.S. dollar against other foreign currencies, that we experienced in the first quarter of fiscal year 2009, makes our pricing less competitive and may 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.
The general worldwide economic downturn we have seen since 2008 is making it more difficult for our customers, our vendors and us to accurately forecast and plan future business activities. External influences that could adversely impact our Oncology Systems business include the 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, brachytherapy and radiosurgery procedures in the United States; government budgeting and tendering cycles and governmental healthcare policies. A customer's decision-making process may be further complicated and lengthened as the current worldwide economic downturn 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. We continue to view the fundamental growth driver
for this business to be the on-going success of key x-ray imaging original
equipment manufacturers, or OEMs, that incorporate our X-ray tube products and
flat panel detectors into their medical diagnostic, dental, veterinary and
industrial imaging systems.
X-ray Products' net orders and revenues grew in the first quarter of fiscal year 2009 over the same period of fiscal year 2008 primarily due to growth in net orders and revenues for our high power, anode grounded CT scanning tubes and our flat panel detectors. 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. The general worldwide economic downturn we have seen since 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. The rising costs of raw materials due to increased worldwide demand which we have seen over the last two years have abated with the recent worldwide economic downturn. Global demand for such commodities has lessened and we have seen decreases in some commodity prices for our materials, which should eventually benefit our product cost structure.
Other. The "Other" category is comprised of Security and Inspection Products, or SIP, the ACCEL Proton Therapy business, and the operations of the Ginzton Technology Center, or GTC. (Please refer to Note 15 "Segment Information" to the Condensed Consolidated Financial Statements within this Quarterly Report on Form 10-Q.)
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 product examination for a variety of applications. SIP also designs, manufactures, sells and services IntellXTM, an imaging product for cargo screening. We generally sell SIP products to OEMs who incorporate our products into their inspection systems, which are then sold to customs and other government agencies, as well as to commercial private parties in the casting, power, aerospace, chemical, petro-chemical and automotive industries for nondestructive product examination purposes.
We believe growth in the SIP business will be driven by cargo screening and border protection needs, as well as by the needs of customs agencies to verify the contents of shipments for assessing duties and taxes. As a result, this business is heavily influenced by U.S. and foreign governmental policies on national and homeland security, border protection and customs revenue activities; these activities depend upon government budgets and appropriations and are subject to political change. In addition, this business depends on the success of our OEM customers. 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.
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 this business'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 will not book orders for proton therapy systems until contingencies are eliminated under our current practice, 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 is the most vulnerable to the general worldwide economic downturn and contraction in the credit and public bond 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.
For the first quarter of fiscal year 2009, the growth in net orders in the "Other" category over the prior year period was primarily driven by growth in net orders for our Linatron x-ray accelerators in the SIP business. The growth in revenues in the "Other" category was also driven by increased revenues from our SIP products.
This discussion and analysis of our financial condition and results of operations is based upon and should be read in conjunction with the Condensed Consolidated Financial Statements and the notes included elsewhere in this Quarterly Report on Form 10-Q, as well as the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements and the related Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended September 26, 2008, or the 2008 Annual Report, as well as the Risk Factors contained in Part II, Item 1A of this Quarterly Report on Form 10-Q, and other information provided from time to time in our other filings with the SEC.
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, estimates and assumptions and make adjustments when facts and circumstances dictate. 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, valuation of derivative instruments and taxes on earnings. Such accounting policies require us to use judgments, often as a result of the need to make estimates and assumptions regarding matters that are inherently uncertain; 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 listed under Part II, Item 1A of this Quarterly Report on Form 10-Q.
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 on 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 we recognize 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 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
We evaluate the credit worthiness of our customers prior to authorizing shipment
for all major sale transactions. Our customary payment terms require payment of:
a small portion of the total amount due when the customer signs the purchase
order; a significant amount upon transfer of risk of loss to the customer; 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 our future ability to
collect outstanding receivables, additional provisions may be needed and our
operating results could be affected negatively.
Inventories
Our inventories include high technology parts and components that are highly specialized in nature and that are 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 businesses that we have acquired have not had significant identified tangible assets and, as a result, we have typically allocated a significant portion of the purchase price 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 these intangibles or to goodwill if indicators of impairment exist. The allocation of the purchase price from business acquisitions to goodwill and intangible assets could have a significant impact on our future operating results. In addition, the allocation of the purchase price of the acquired businesses 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.
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