Varian Medical Systems Second Quarter FY2017 Earnings Results Conference Call
April-26-2017
Confirmation # 13658758
Page 1
VARIAN MEDICAL SYSTEMS
Second Quarter FY2017 Earnings Results Conference Call
April-26-2017
Confirmation #13658758
Operator: Greetings, and welcome to the Varian Medical Systems Second Quarter 2017 Fiscal
Year Earnings Results Conference Call. At this time, all participants are in a listen-only mode. A
brief question-and-answer session will follow the formal presentation. If anyone should require
Operator assistance during the conference, please press star, zero on your telephone keypad.
As a reminder, this conference is being recorded. It is now my pleasure to introduce your host,
Mr. Spencer Sias, Vice President of Investor Relations and Corporate Communications for
Varian Medical Systems. Thank you, Mr. Sias. You may begin.
Spencer R. Sias:
Thank you.
Good afternoon, and welcome to Varian Medical Systems
conference call for the second quarter of fiscal year 2017. With me are Dow Wilson, President
and CEO, Elisha Finney, CFO, and Magnus Momsen, our Controller. Dow and Elisha will
summarize Varian results and will take your questions following the presentation.
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To simplify our discussion, unless otherwise stated, all references of the quarter or year are
fiscal quarters and fiscal years. Quarterly comparisons are for the second quarter of fiscal 2017
versus the second quarter of fiscal 2016. References to financial results for orders are to gross
orders, unless otherwise indicated. The Company’s reporting non-GAAP results in order to
provide quarter-over-quarter comparisons of operational performance, excluding unusual
items. Unless otherwise stated, all financial results are discussed from continuing operations
on a non-GAAP basis. Results exclude, for all periods, the Imaging Components business which
is now operating separately as Varex Imaging, and is accounted for as a discontinued operation.
A reconciliation to the most comparable GAAP measure for Varian is included in our earnings
release which can be accessed on our website.
Please be advised that this presentation and discussion contains forward-looking statements.
Our use of words and phrases such as outlook, believe, expect, anticipate, could, should, will,
promising, and similar expressions, are intended to identify those statements which represent
our current judgment on future performance or other future matters. While we believe them
to be reasonable based on information currently available to us, these subjects—statements
are subject to risks and uncertainties that could cause actual results to differ materially. Some
of the important risks related to our business are described in our second quarter earnings
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release and in our filings with the SEC. We assume no obligation to update or revise the
forward-looking statements in this presentation and discussion because of new information,
future events, or otherwise.
Before turning it over to Dow, I want to inform you that I’m retiring in June after 18 great years
with a great company. So, this is my 73rd and last call with all of you, which is probably enough
for anybody, and it has been a pleasure to work with you, and I want to thank you for the
support you’ve shown me and Varian for all these years. I’m as excited as ever about the future
of this Company, and I expect to continue being a Varian investor, like all of you, for many more
years. Thanks again for your support, and now, here’s Dow.
Dow R. Wilson: Good afternoon. I’m pleased to report that our financial results for the second
quarter of fiscal year 2017 were at the high end of our earnings per share expectations.
Highlights included solid growth in orders and revenues in our Oncology Systems business, a
new system order in our Particle Therapy business, improved gross margins in our Oncology
business, and stepped-up investment in SG&A for market development and new product
introductions. Additionally, we successfully completed the spin-off of the Imaging Components
business as Varex Imaging, which is off to a great start.
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To summarize Varian’s second quarter results, we are reporting GAAP earnings from continuing
operations of $0.74 per diluted share, and non-GAAP earnings from continuing operations of
$0.89 per diluted share, companywide revenues of $655 million, up 6%, solid Oncology orders
of $648 million, up 5% in dollars and 6% in constant currency, bringing year-to-date orders
growth to 7% in dollars and constant currency, and a $26 million equipment order for a singleroom Proton system in Delray, Florida.
Focusing first on Oncology operations, we had a good quarter with solid order growth in
emerging markets as well as healthy orders for software in North America and equipment in
EMEA. Looking specifically at order growth rate in each region, Oncology grew gross orders in
the Americas by 3% in dollars and constant currency. Orders in North America were up by 3%,
bringing the year-to-date order growth in this region to 5%.
Looking at some highlights; in the Americas, we took orders to replace 12 accelerators from
competitors. We also took numerous software orders for replacement of competitive software
for treatment planning and information management. Among the competitive conversions was
a $20 million, 10-year software commitment from Orlando Health. They will install our full
suite of software including Eclipse, ARIA and Velocity Systems, and our FullScale managed-
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services package. We booked nearly $7 million of that order in the second quarter, and we’ll
book the rest as installations are scheduled.
Elsewhere in North America, we booked 6 TrueBeam orders for installation at CHUQ in Quebec
City and then another 3 TrueBeam orders for Rhode Island hospital in Providence. In Latin
America, orders grew by nearly 10% versus a relatively small year-ago number, with order
activity driven primarily by Brazil, where construction of our new Complexo for Education and
Manufacturing is nearing completion.
While the sales funnel across Latin America looks
promising, activity is slow and we continue to be cautious about the rate of recovery in this
market.
Turning to EMEA, orders rose 6% in dollars and 10% in constant currency. Africa, the Middle
East, and Western Europe were the biggest growth drivers in this region. Business in Africa has
more than doubled over the past year and has risen successfully—successively for the last four
quarters. As you may have seen from our recent press release, we’re now selling direct in
South Africa. Among the highlights in Africa were orders for the first Edge Radiosurgery System
in Morocco to serve the North Africa sub-region, and a low energy linear accelerator in the
Democratic Republic of Congo, which is the first modern linear accelerator in a country of more
than 80 million people. We also generated notable orders in Tunisia as well as in Turkey and
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Israel. Spain and Portugal contributed strongly to EMEA’s Western European growth during the
quarter, placing orders for a total of eight accelerators including four TrueBeams, two
VitalBeams, and two Clinacs.
In APAC, gross orders rose 8% in dollars and 7% in constant currency. Service grew in doubledigits but product sales also played a key role in this region. Orders in China rose by 8% and we
believe we have a leading share in this market, particularly in the high-end segment with
products like Trilogy, VitalBeam, TrueBeam, and Edge. We’re on track to top $225 million in
orders in China this year. We also saw good order performance in Korea and the Philippines.
We also received our first order in Cambodia for an accelerator and brachytherapy unit for
Cambodia’s largest public hospital, Calmette. During the quarter, we hosted three users’
meetings in APAC including Beijing, Bangkok, and Melbourne. We welcomed more than 1,000
customers at these terrific events where our presentations focused on radiotherapy
innovations, radiosurgery, and the role of immunotherapy.
Turning to our Global Service business, we grew orders by 8% in the quarter and 7% for the first
half. This more than $1 billion annual business is continuing to grow faster than oncology’s
overall growth rate and contributing to margin expansion. On the hardware front, TrueBeam
continued its momentum with more than 1,700 installations worldwide or about 20% of our
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global install base. TrueBeam is a widely accepted product that addresses a clinical need in
every region of the world. It is a versatile platform capable of delivering every type of
treatment, from radiotherapy to radiosurgery, with either electrons or photons and at multiple
energy levels. We are continuing to add to TrueBeam’s capability and later this year, we expect
to introduce the first version of our HyperArc module for high-definition head and neck
radiosurgery with ultra precise doses that cannot be matched by any other system on the
market.
We’re also making good progress with software. As of the end of the quarter, we had about
800 licenses ordered from more than 375 sites for our RapidPlan product that significantly
enhances the quality and speed of treatment planning. The ramp-up of this product has been
tremendous. We see more opportunity ahead as less than 10% of the treatment planning
install base has adopted this technology since its introduction 18 months ago. Our InSightive
analytics software for identifying and removing bottlenecks in the clinical workflow has been
ordered at more than 180 customer sites, who will use it to improve their clinical effectiveness
and operational efficiency. We’re building a robust pipeline of prospects for our 360 Oncology
product.
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I will now turn to our Particle Therapy business, which generated $31 million in revenues during
the quarter and recorded $28 million in orders, including the Delray project. This project is
being financed in part by the sale of $81 million in bonds, including $11 million of subordinated
bonds purchased by Varian. Several other centers in the US are working on similar bond
financing. In addition to the Delray order, Varian’s ProBeam compact single room system has
been selected as the equipment-of-choice for a center in Thailand and we hope to book that
order in the third quarter when the requisite paperwork is processed. Our Proton sales funnel
looks promising with another two to four projects that have the potential to be booked this
year.
Before turning it over to Elisha, I want to take a few moments to call your attention to some
recent promising studies on the role of radiotherapy for prostate and bone cancer, as well as
some lung cancer studies. The New England Journal of Medicine has published two recent
positive studies for radiotherapy. The first shows that untreated prostate patients had more
disease progression and metastatic disease compared to treated patients. The study in the UK
involved 1,600 patients who were randomized to either watchful waiting, radical
prostatectomy, or 3D conformal radiotherapy, over a 10-year period. The second study found
no clinically significant difference in disease control between patients treated with either
radiation or surgery. However, patient-reported quality of life outcome showed that surgery
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had the greatest negative effect on sexual function and urinary continence. In contest—in
contrast, radiotherapy had little effect on urinary continence. Bowel toxicity was slightly worse
with radiotherapy, but that largely cleared up after six months except for a minor increase in
more frequent rectal bleeding.
Today, most radiotherapy for prostate cancer uses image-guided IMRT, a more precise method
of dose delivery. Also, ASTRO recently just published guidelines for palliation of bone mets with
radiation, which continues to be the gold standard for palliative care. While 88% of hospice
professionals believe radiotherapy should be used for pain control, only 3% of hospice patients
actually receive it. A study in Canada showed similar results. Combined, these studies suggest
that not only is radiation for bone mets effective, it is also underutilized.
Finally, two papers were presented recently at a Thoracic Cancer Meeting in San Francisco. The
first was a multi-institutional study that analyzed patients over 80 years old with early stage
non-small cell lung cancer treated with radiosurgery.
Despite their age, these patients
tolerated radiation quite well with a two-year local control of 84.5% and a cancer-specific
survival of 73%, dispelling the myth that elderly patients cannot have curative radiation.
Second, preliminary results were reported in an abstract looking at 27 lung cancer patients
retreated with Proton therapy at MD Anderson. These patients typically do poorly but in this
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study, 78% of patients had their tumors controlled at one year and had an impressive median
survival of 18 months. Though retrospective, this small study does suggest that Proton therapy
may be an important tool for recurrent, previously radiated tumors.
Now, I’ll turn it over to Elisha.
Elisha W. Finney: Thanks, Dow and hello, everyone.
We have already covered orders and operations, so let me start with backlog. We ended the
quarter at $3.1 billion, up 4% from the year-ago period including a 6% increase in the Oncology
backlog to $2.9 billion. Backlog adjustments during the quarter totaled $50 million, bringing
net orders for the Company to $625 million.
Now, let me walk you through the P&L. Second quarter total company’s revenues from
continuing operations were $655 million, up 6% in dollars and up 7% in constant currency.
Oncology revenues totaled $624 million, up 7% in dollars and in constant currency versus the
year-ago quarter. International revenues rose 10% and constituted 52% of Oncology revenues
in the quarter. Year-to-date, Oncology revenues were up 3% in dollars and in constant
currency.
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Our Particle Therapy business posted revenues of $31 million, up 1% from the year ago quarter
driven by ongoing progress on installations. Year-to-date, Particle Therapy revenues were up
7%.
The total company gross margin for the quarter was 42.2%, up 7 basis points with a one-point
gain in Oncology, largely offset by declines in the Proton business. Oncology Systems gross
margin increased by a point to 44.5% due to a favorable product mix as well as product cost
reductions. For the first half, Oncology gross margin is up almost 3 points to 45.6%. Proton
Therapy gross margin was a negative 3.6%, due largely to revised profitability estimates on two
projects in the UK where the pound is at a historical low. For the first half, Proton gross margin
is down from the year-ago period to 6%. For the first half, total company gross margin was up
more than 2 points to 43.7%.
Second quarter SG&A expenses were $118 million or 18% of revenues, in line with our
expectations as we accelerated investments in the introduction and commercialization of new
products. Second quarter R&D expenses were $53 million or 8% of revenues, equal to the yearago quarter as a percentage of revenue. Second quarter operating earnings totaled $106
million or 16% of revenue, down from the year-ago quarter due to the lower Proton gross
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margin and the increased investment in SG&A. Depreciation and amortization totaled $19
million for the quarter. The effective tax rate was 21.6% for the quarter, lower than expected
due to a large revenue shift to EMEA where rates are relatively low.
For the balance of the year, we believe Varian’s tax rate will be about 24% to 25%. During the
quarter, we spent a $173 million to repurchase 2 million shares of stock. Fully diluted shares
outstanding decreased 2.5 million from the year-ago quarter to 93.7 million, due to our ongoing
share repurchase program.
Diluted GAAP EPS from continuing operations was $0.74 for the quarter. Non-GAAP EPS from
continuing operations for the quarter was $0.89. Year-to-date, non-GAAP EPS from continuing
operations was $1.47 including the $0.34 impact from Proton accounts receivable impairments
in Q1 versus $1.67 for the same period last year.
Turning to the balance sheet, we ended the quarter with cash and cash equivalents of $706
million, debt of $547 million, and stockholders’ equity of $1.3 billion. DSO at a 108 days was
down nine days from the year-ago period, due exclusively to significant improvements in our
Oncology business, which is at 96 days. Cash flow from operations including discontinued
operations was $32 million for the second quarter and $114 million for the first half.
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Primary uses of cash were $173 million toward the repurchase of 2 million shares of stock and
$15 million for cap ex. As of today, we have 6 million shares remaining under our existing
repurchase authorization.
This is my last call as well, and I will be retiring as CFO on May 8. For me, it has been a
tremendous pleasure to work with you and I thank you for the support that you have shown me
and this great Company. Like Spencer, I will be a long-term Varian shareholder and my blood
will always run Varian Blue, and now, let me turn it back to Dow.
Dow R. Wilson: Thanks, Elisha. We now believe that for the second through fourth quarters of
fiscal 2017, total company revenues from continuing operations will grow in the range of 3% to
5% depending on the timing of the Proton orders. For the full fiscal year, total company
revenues from continuing operations should grow in the range of 2% to 4%. For the second
through fourth quarters, we expect that earnings per diluted share from continuing operations
would be in the range of $2.98 to $3.06. For the full fiscal year, earnings per share from
continuing operations should be in the range of $3.56 to $3.64, including the $0.34 impairment
of Proton account receivable—account receivables in the first quarter. For the third fiscal
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quarter, we believe Varian revenues from continuing operations will grow by about 3% and we
expect that non-GAAP earnings per diluted share will be in the range of $0.92 to $0.96.
To summarize the second quarter, we had solid orders and revenue growth in Oncology
Systems, a new single-room Proton order, a gain in our gross margin, and earnings at the high
end of our target range. We’ve stepped up our investment in market development as well as
new product introductions that will drive continued growth around the globe. I want to remind
you to attend our Investor Meeting next week at the New York Stock Exchange or via webcast.
You can get details on our Investor Relations website. We’re excited about the future and
we’re looking forward to the rest of fiscal year 2017.
Before turning it over to your questions, I’d like to acknowledge Elisha and Spencer for their
many contributions to the Company, seventy-plus quarters together, what’s the exact count?
Elisha W. Finney: Seventy-three.
Dow R. Wilson: Seventy-three quarters together, that’s more than imaginable and we are so
grateful for their contributions, for the advocacy they’ve had for our customers, for our
shareholders, for our employees, and for the communities that we live and operate in. They’ve
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been great business partners and on behalf of myself and the Company, we wish to thank
them. We’ll miss their leadership and we’ll miss the blond hair flip and the voluble banter and
so with that, we’ll open up for questions. Thank you, Spencer and Elisha.
Spencer R. Sias: Hey, thank you very much, Dow. I just want to thank you for those comments
but I also want to just to inject a quick correction. We talked about the Investor Meeting next
week at the New York Stock Exchange. It is on May 10…
Dow R. Wilson: May 10.
Spencer R. Sias: …which is the week after next and so the details are there and not your fault.
It’s just my final error, I hope.
Dow R. Wilson: May 10, and we’re now open for questions.
Operator: Thank you. At this time, we will be conducting a question-and-answer session. If
you would like to ask a question, please press star, one on your telephone keypad.
A
confirmation tone will indicate your line is in the question queue. You may press star, two if
you would like to remove your question from the queue. For participants using speaker
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equipment, it may be necessary to pick up your handset before pressing the star key. One
moment please while we poll for questions.
Our first question comes from the line of Jeff Johnson of Robert W. Baird. Please proceed with
your question.
Jeff Johnson: Yes. Thank you. Good morning, guys. Elisha and Spencer, congratulations on the
retirements and best of luck to you, and Elisha how you survived 73 quarters with that man, I
will never know.
Elisha W. Finney: Thank you, Jeff.
Jeff Johnson: Spencer, that was supposed to be a backhanded compliment to you as well. So,
congratulations.
Spencer R. Sias: Yes, I got that. I got that, Jeff. Thank you.
Jeff Johnson: So, a couple of questions. Dow, first just on guidance. You really came in at,
revenue-wise, above kind of the three-quarter guidance that you’ve been providing. You came
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up above that from a revenue perspective this quarter. But you are lowering the low end of
that three-quarter revenue guidance. So, just trying to figure out the dynamics of a third—a
second quarter that was kind of above expected but now guidance is being trimmed at the
bottom end and what’s driving that, and then a second guidance question, just it looks like tax
rate guidance is now adding about a dime relative to what we were thinking going into this
quarter for the rest of the year and yet you’re not changing EPS guidance. So, any color there
would be helpful as well. Thank you.
Dow R. Wilson: Yes, Elisha, go ahead.
Elisha W. Finney: Yes. Jeff, so let me take the tax first. So, yes, it was lower than we expected
in Q1. It ended up being roughly an exact offset to the reduction in the Proton gross profit that
we were expecting. So, we hit the high end of the guidance range for the quarter, although the
geography was a little different.
For the balance of the year, we continue to believe that tax is going to be—now, we think in the
24% to 25% range, which will get you up to about, call it, 24% for the year. We had previously
guided 25% to 26%, so we’re getting about a 1-point improvement in the tax rate, largely offset
by the Proton gross profit and I think, we said last quarter, the biggest unknown in this whole—
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doing the discontinued operations and spinning out of Varex, the tax rate was kind of the
cloudiest, if you will, for us to see. The good news is, we were able to shave that a point and
again, we think the full year closer to 24%, which should be sustainable going forward.
So, in the guidance, again, because we got an improvement in the tax rate, the gross profit for
the year for Proton, we’re losing somewhere around $6 million or $7 million. So, that tax is an
offset to that. The gross profit for Oncology, right in line with what we were expecting in the,
call it the 44% to 45.5% range, SG&A, maybe a million or two high, but within our expectations.
So, we simply raised the midpoint at this point in the quarter from $3 to $3.02 for the balance
of the year and came off the low end of that guidance number. Does that answer your
question?
Dow R. Wilson: Yes, I think on the revenue side, really on the timing of protons...
Elisha W. Finney: Yes...
Dow R. Wilson: ...proton deals, that’s showing up at the bottom end of the revenue guidance.
Elisha W. Finney: Yes.
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Jeff Johnson: Okay and, Dow, maybe one follow-up just on the Proton side. So, when I think
back five, six years ago when you first announced the Scripps deal and you balanced the risk
with that, I think one of the explanations was you had to get a win on the board and if you have
to put your balance sheet at risk to kind to get a win on the board, that makes sense. Over the
last few years, there’s been a couple other financing deals you guys have been involved with,
but they’ve been big systems. They are multi-room systems and we kind of thought, as we go
to single-room systems and you’ve got 16, now 17, orders out there, you didn’t have to prove
yourself anymore. On this new deal, single-room system, you still have to put the balance
sheet at risk.
So, I guess, what is driving that need to continue to put the balance sheet at risk now that you
have plenty of orders out there, you’ve proven yourself, the orders are getting smaller yet
you’re still having to get involved to get these things over the finish line?
Dow R. Wilson: I think—I mean, first of all when you look at this deal, Delray, it’s about $80
million of capitalization. We are $11 million of it. As I mentioned in the script, we think there’s
a few more like that. These are deals that look pretty good to us from a profitability point of
view. It remains difficult to finance. Having said that, when you look at the risk, when you look
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at the ramp-up of centers, pretty much every center that we have and that we know about, as
we’ve looked at that ramp-up on these single-room systems, they get to profitability pretty
quickly. So, the issue has been these three- and four-room centers have a lot of capital in them
and the breakeven point is much, much higher.
On these single-room systems, the breakeven point’s much lower. We think they’ll get to those
volumes very quickly, should be able to be refinanced and if we can help bootstrap that and get
it going, we’re very much into it. So, we do view this segment as a—this compact segment as a
distinct segment to the Proton market. We will use our balance sheet selectively there. We are
vetting the risks very carefully so that we’re in with others. We’re looking very hard at the
referral networks and patient volumes to make sure they can get to those levels and if we do it,
it’s also a profitability case. The interest income is not negligible on these loans.
Elisha W. Finney: Yes. If I could just add one thing to that, I mean, this is a developer deal with
Proton International. Everybody has some skin in game in this particular deal, Jeff. So, the
doctors have money in.
Everybody came together to get this to happen and it was
oversubscribed on the muni-financing by a significant amount. So, we took that as great news
that there is a real market for financing these one-room centers.
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Jeff Johnson: Thank you.
Dow R. Wilson: Yes, and maybe I’d just add, we’re not going to go crazy on this. We might—if
everything went our way, maybe two more of these in the next six to 12 months. I mean, at the
high end, three. So, it’s not going to be—we’ve still got Maryland out there—I’m sorry, not
Maryland. We’ve still got Emory out there, that we’ve talked about, and then supporting a few
of these compact deals as well. Next question?
Operator: Our next question comes from the line of Amit Hazan of Citi. Please proceed with
your question.
Amit Hazan: Thanks, and good afternoon, guys, and Elisha and Spence, thanks for all the help
over the years and good luck in the next chapter.
Elisha W. Finney: Thank you.
Spencer R. Sias: Thank you.
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Amit Hazan: So, let me just actually start with orders first and go to the US environment. I
mean, if I’m just kind of reading or understanding your comments correctly, it sounds like
software was very strong, the implication being that hardware was maybe a little bit less
strong, and so I’m just wondering in the US market, did you see any changes in purchasing
patterns with the uncertainty going on or has it been pretty much the same?
Dow R. Wilson: I’d say it’s been pretty much the same. We feel very good about the first half
orders performance in the US. So, that’s been, looking at the half, it’s been strong, and frankly
looking back five or six quarters, it’s been very steady. One of the things that we liked this
quarter was the software volume was up. So, I mean, equipment bounces around a little bit.
It’s a little bit lumpier. The software volume was up double-digits and we were very pleased
about that. I’d say no real difference in the US market.
Amit Hazan: Okay, and then let me jump to cash flow actually. So, thinking about it, ’16, this
came up a few times, free cash flow was down a lot, like 25% or so I think in ‘16. Free cash flow
conversion used to be really strong in the 80s or so. Cash flow looked kind of weak again this
quarter. Maybe give us some color on what’s going on there, and what we should expect for
the rest of the year.
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Elisha W. Finney: Sure. So, Amit, again, just given the spin, let me clarify that cash flow from
operations is not on a continuing operations basis. So, you typically don’t try and go back and
parse the cash flow from operations from one entity to the other. So, for the first half, and I
always like to look at this more—I mean, you’re going to get quarterly fluctuations. For the first
half, cash flow from operations was $114 million. We estimate, again, this is not a number that
will show up in a public filing, but we believe that about $94 million of that is attributable to
Varian, with the rest being attributable to Varex.
Remember, we’ve also had significant transaction expenses associated with the spin and on
hiring people to get ready for the spin. So, if you were to just add maybe—we still have some
transaction expenses that have not been paid yet but even if you add somewhere around $15
million, $17 million of that being in transaction, and the first half is usually about 40% of the full
year, which gets you up around $275 million, $280 million for Varian standalone for the year,
and what we’ve said is, our hope is that we were $400 million with Varex, and it would be
probably closer to around $300 million. So, I think we’re somewhat in that—we’re in that
ballpark, as we speak.
Amit Hazan: Okay. Let me just sneak one more and then I’ll jump back in. So, back to the
operating margin, just as a follow-up to the earlier question. I think in your pro forma numbers
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that you guys filed, it looked like your operating margin, kind of at Varian as a standalone post
without the spin or after the spin, is about 18% in fiscal ‘16. I think you’re talking about 18% to
19% for this year. It sounds like this was a one-time type of item on the Proton side this
quarter. Correct me if I’m wrong, but is the aspiration here for the rest of the year, is 18% or so
is the right number for the rest of the year? Are you going to have lingering Proton operating
margin issues? How should we think about the operating margin line for the rest of the year?
Elisha W. Finney: You’re absolutely right, Amit. Once you pencil this out, you will see that pro
forma continuing—continuing operations for all of last year, we were 18.1%. If you look at the
guidance, Q2 to Q4, we will be right around 18%. What that means for the year, and again, I
am excluding the impact of the Proton AR write-off, so you guys can figure out how you want to
reflect that but for the full year, it puts us 17% to 18% operating margin, which is where we
thought we were going to be this time last quarter. So, we’re not coming off that number.
Amit Hazan: Thanks very much.
Operator: Our next question comes from the line of Anthony Petrone of Jefferies. Please
proceed with your question.
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Anthony Petrone: Great, and congratulations, again, Elisha and Dow. Thanks for all of the help
through the years here. Just to stick on Proton for a moment, just want to clarify what exactly
is in guidance and what maybe potentially still represents upside, and so if I’m hearing you
correctly, Dow, the Delray order and the order in Thailand are now factored into guidance, and
then there are several other orders, I guess two to four orders including Emory, that represent
upside to guidance. Is that sort of a fair statement?
Elisha W. Finney: So, Anthony, just to clarify, I mean, we—when we start the beginning of the
year, we have our backlog of what, if you will—of Proton orders that we believe we’re going to
book throughout the year, and as soon as we book an order, we start taking revenue under the
percentage of completion. So, the timing of those orders can impact revenue, and clearly,
that’s why we came down a little bit on the revenue forecast for the balance of the year. So,
the Delray deal, it was already in our forecast. So, the only upside at this point is the Emory
deal. We’ve been very transparent that it is because it is one of these very large five-room
centers in the midst of getting their muni bond financing put together, we have not included
that in our numbers because it has the potential to swing it very significantly.
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Anthony Petrone: Just to clarify on the swing, I think from my notes last quarter, it was a $0.10
to $0.12 swing the earlier in the year it was finalized. I mean, what is the update on that now,
just maybe considering the time on the calendar that has passed?
Elisha W. Finney: Yes, it’s still in that ballpark. I mean, it would have more significance on the
orders and the revenue because we will start the—we’ll start taking earnings on that but that
will obviously flow all the way throughout the installation and acceptance of the equipment.
So, that’ll be several years.
Anthony Petrone: Great, and then just a follow-up on balance sheet utilization within Proton
and maybe across the business, maybe just an update on, in aggregate, how many Protonrelated loans or loan products are held on the balance sheet and in particular to the Scripps
loan, is that completely written off at this point? Thanks.
Elisha W. Finney: No. So, currently, we have $60 million in the balance on the Scripps loan.
That was after we sold $45 million to JP Morgan a number of years ago. Maryland, our loan
amount is $35 million, New York just shy of $20 million, and then we add Delray. So, what is
that, about $125 million all-in at this point.
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Anthony Petrone: Thanks.
Operator: Our next question comes from the line of Tycho Peterson of JP Morgan. Please
proceed with your question.
Tycho Peterson: Hey, thanks. Dow, I’m wondering if you could—and congrats to Elisha and
Spencer. Dow, I’m wondering if you can comment on pricing dynamics. You talked about the12
competitive wins in the US. As you go to kind of swap out some of these competitor vaults, are
you able to hold on the pricing?
Dow R. Wilson: Our pricing dynamics continue to be okay. Elekta remains aggressive. I don’t
know that they’re any more or less aggressive than they’ve been in the past and we’ve seen
pretty good engagement. I will say that one of the things that was a little unique about the
quarter is that the takeouts were broad-based across all our competitors. We had good
takeouts against Accuray, good takeouts of old Siemens product as well as a few Elekta units.
So, it was pretty broad-based and that’s something that we’ve seen in the past. I don’t know
that that’s—it might be a little bit more on the quarter, but not materially more. I think when
you look at the last half, TrueBeam pricing remains pretty solid and clearly upselling with Edge
and getting some positive mix, the US market continues to be pretty good. Other Americas
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activity, as it can be aggressive from time to time but in the US, the pricing environment’s been
pretty stable.
Tycho Peterson: I know you talked about the US holding up. I mean, the data points from GE,
Philips and some of the others have been a little more mixed. I mean, is there any risk to you
guys, because you guys are late cycle, there may be a little bit of a lag effect?
Dow R. Wilson: Certainly not anything that we’re seeing at this point.
Tycho Peterson: Okay.
Dow R. Wilson: If anything, I think that the strength of the portfolio and the rumored product
introduction in a couple of weeks, we’ve—if anything, maybe we’ll even see it pick up a little
bit.
Tycho Peterson: I guess on that point, you talked about seeing strength in emerging markets
with some of the higher-end systems. I mean, can you maybe just directionally give us a sense
of where you see a gap in the portfolio from a LINAC perspective?
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Dow R. Wilson: Yes. I mean, first of all, I got the week wrong, but come to New York. We’ll talk
extensively about it in two weeks, and if you like opera, come to Vienna. We’ve—the European
Society of Radiation Oncology meeting is in Vienna right before that, and we’ve—as we’ve kind
of talked, what these emerging markets are looking for is really high-quality IMRT. They’re
looking for very fast, high-quality imaging. They don’t want to make any trade-off in the quality
of care, and then they want to do bulk-in (phon) patients, and that’s kind of the, when you
think of it in market needs—and maybe the other thing I’d add is simplicity. They want a high
level of automation. They want to go fast. They don’t want the training burden that certainly
the industry was a long time ago, and as we think about—as we think about the market needs, I
think we’ve got some really exciting news coming and look forward to seeing you in a couple of
weeks.
Tycho Peterson: All right, and then just last one maybe for Elisha on the revised profitability
estimate on the UK project, that was all due to currency or were there any adjustments around
utilization assumptions?
Elisha W. Finney: It’s largely currency, Tycho, yes, just the pound being at a historical low.
Tycho Peterson: Okay. Thank you.
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Operator: Our next question comes from the line of Brandon Henry of RBC Capital Markets.
Please proceed with your question.
Brandon Henry: Yes. Thanks for taking my question. There’s been a lot of concern from the
investor base about the Company’s lengthening cash conversion cycle, particularly as it relates
to inventories and receivables. So, can you give any specifics there that can help us get more
comfortable around what you guys are doing to improve these metrics?
Elisha W. Finney: Yes. Well, first of all, AR since the beginning of the fiscal year, is actually
down 1% while its revenue is up 3%. So, we are making considerable inroads into—we’ve
had—we told you a year or so ago, we had a Salesforce.com implementation. We moved our
collections staff. Collections continue to be quite robust and the DSO for Oncology is down 10
days, quarter-over-quarter, to 96. So, what’s driving—as Proton grows, that will drive the DSO
up just because of this percentage of completion accounting where revenue and earnings are
taken in advance of when the actual payments are due from the customer. Inventory is only up
very slightly from the beginning of the year, just in line with revenues. So, I think we’re making
good progress. Remember, on this cash flow from operations, again, significant transaction
costs included in those numbers.
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Brandon Henry: Okay, and then a separate question. I think you guys have started to talk
about a potential launch for a new LINAC later in fiscal year ‘17. Are there any details you can
give us regarding this product, what features or margin profile it may have and then what
geographies you’re going to target for this launch?
Dow R. Wilson: I mean, as I just said, we’ll see you in Vienna or New York. We’ve got a very
exciting product. I think we’re confident it will be margin-accretive, and come hear about it
with the rest of our customers in two weeks. I think it’ll be a very exciting launch.
Brandon Henry: Okay, and one last one for me. Can you give us an update on what kind of
trends you’re seeing in the Chinese radiation oncology market, and then can you give us any
updated timing on when a Class A quota might be announced?
Dow R. Wilson: Well, I think our China business has been very robust for a good strong period
of time. We were up 10% this quarter. Our Team is executing very well in that market. We’ve
been double-digit-ish for many quarters in a row. We just had a users’ meeting in China. We
had over 600 attendees. So, very good reception. Our market share is leadership position now
in China. So, we’re comfortable that the share is going in the right direction and—the whole
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market, I wouldn’t get—yes, there are category A, category B issues. But we’ve got to watch
the whole market, here, and the whole market is moving and as I said in the script, we’re well
on our way to a $225 million business. We’ve got a great portfolio and we think the news that
you’re going to see in a couple of weeks, it’s going to require—probably require some
regulatory approvals in China but it’s going to be very meaningful for that market as well.
Brandon Henry: Okay, and then are you aware of a new Class A quota or is that still kind of
TBD?
Dow R. Wilson: Not aware.
Brandon Henry: Okay. Thank you.
Operator: Our next question comes from the line of Vijay Kumar of Evercore ISI. Please
proceed with your question.
Dow R. Wilson: Hi, Vijay.
Vijay Kumar: Hey, guys. How is it going?
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Dow R. Wilson: Well.
Vijay Kumar: Elisha, again, wish you all the best for your next chapter, you too, Spencer, and
maybe on, I guess the guidance, so revenue’s down by 100 bps and EPS up at the low end. Can
you just change—explain, or walk me through on what changed between the revenue line and
the EPS?
Elisha W. Finney: Yes. So, the revenue line is exclusively due to Proton and just some timing of
orders primarily, because as you know, under percentage of completion at the time we book an
order, we start to recognize revenue over the life of that project completion. So, timing of
orders is driving that and we—Oncology continues to be right where we were at the last
quarter. So, EPS, again, it’s just a little bit of difference in geography on the P&L but the gross
profit and decline versus what we were expecting in Proton, almost an exact offset to the onepoint improvement for the year that we’re expecting in the tax rate, and so that’s why we were
able to come off the mid-point, come up $0.02, come off the bottom of the EPS range.
Vijay Kumar: Got you, and then the backlog, I guess, the way the accounting works is now—I’m
assuming you’re pulling off some of the imaging components, maybe a couple of hundred
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million dollars. What’s been the backlog growth for the last few quarters? Because I guess I
don’t have the historical numbers here, apart from the second quarter numbers, right, which
just includes the Oncology piece and the Proton piece. So, can you give us a sense for what it’s
been over the last few quarters under the new reporting methodology?
Elisha W. Finney: Sure. So, you are correct that Varex came out of the backlog. So, as of Q1,
let’s see, before we carved it out for disc op it was—the backlog was 3,389, we’re now at 3,136.
So, you’re right, a couple of hundred million came out for the Varex Group. As of Q1, Oncology,
$2.9 billion, we’re still $2.9 billion, which was up 6% quarter-over-quarter. We do have a
decline in the Proton backlog because we did book Delray, but we have yet to book that
Thailand order and we’ve been taking revenue over the course of this year. So, Oncology
backlog is strong, up 6% at $2.9 billion.
Vijay Kumar: I guess I was looking for some historical information. Is there—can you provide
some historical information over the last—what it’s been under the new reporting segments,
right, either on the P&L and the backlog? I guess a part of the issue is, when I try to look back
on what’s happened over the last year, I guess the quarterly numbers, it’s hard for us to parse
out under the new reporting methodology. So, if you can have that information, I think that
would be really helpful for us.
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Maybe one for you Dow, big-picture question, I think, on the competitive side.
Your
competitor’s making some noise about MR LINAC, and I know you have a certain view on this,
but I’m just curious on that, on what you’re hearing about in the marketplace—and I am just
curious about the timing of the new products that you guys are launching. Is this sort of in
response to what competition is doing or are these two things completely unrelated?
Dow R. Wilson: I mean, the short version is, there is a—number one, we believe that MR
imaging is important. That’s been growing in importance in radiation oncology and we use that
imaging for treatment planning and guidance, literally every day today. We’re not convinced
that MR in-room is more than a small niche and that remains to be seen how big a niche that’s
going to be, and at least in terms of as we think about our focus, we’re looking at that product
that can have a global impact. I like to think of this in terms of, today we’re at 13,000 units in
our install base. The world needs, at a minimum, another 10,000 machines and it needs to
replace another 13,000 machines. So, how do we really grow the sockets that are doing
radiation therapy?
Many countries in the world have—less than 10% of their cancer patients are getting radiation
as part of their therapy. In the West, that number is around 50%, and there’s just a huge
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opportunity there. So, that’s kind of how I view the global play, and then from a technology
point of view, we do agree that adaptation is important, and that’s one of the things that MR is
bringing. But you can do adaption in lots of ways. It doesn’t have to be with MR. So, I think
you will see us compete very aggressively for kind of the top technology space with ongoing
conformality and adaptation kinds of plays, along with simplicity and automation. So, I think
we’re—but when we look at the markets, I mean, for us, it’s how do we do 10,000 more
machines?
Vijay Kumar: Got you. Thank you, guys.
Operator: I would like to remind all participants, if you would like to ask a question at this time,
please press star, one on your telephone keypad.
We have a follow-up question from the line of Anthony Petrone. Please proceed with your
follow-up.
Anthony Petrone: Thanks. Maybe just on the regulatory pathway for the system and timing
there, and if this is included in guidance at all. Thanks.
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Dow R. Wilson: The short version is, I’ll talk to you in two weeks. I mean, I think we’ve got—
we’ve got a very exciting product. It’s, from a guidance point of view, very minimal. It’s—we’re
largely talking about ongoing impact and orders impact which of course we do not guide to. So,
but very excited about the product and we can talk more about kind of the regulatory process
when we see you in New York.
Elisha W. Finney: But Anthony, it’s more of an FY18 on the revenue side...
Dow R. Wilson: On the P&L side.
Elisha W. Finney: On the P&L side. Yes.
Anthony Petrone: Yes. That helps. Thanks.
Operator: We have another follow-up question from the line of Jeff Johnson of Robert W.
Baird. Please proceed with your question.
Jeff Johnson: Thanks. Elisha, just quickly...
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Dow R. Wilson: Hey, Jeff.
Jeff Johnson: Hey, Dow. So, just very quickly, is there anyway can provide us with just accounts
receivable numbers maybe over the last couple of years and the first two quarters of this year,
for just the Oncology business, kind of ex-protons and obviously ex-Varex?
Elisha W. Finney: I don’t have it now, Jeff. You’re saying on a go-forward basis?
Jeff Johnson: Yes. On a go-forward basis or maybe you could post at some point on the page.
Elisha W. Finney: Sure.
Jeff Johnson: Yes. Because I think a lot of the focus here recently on the working capital has
been on the AR side, and the accounting for the Proton stuff, I think, obviously as you
described, is one of the big impacts but if we could see on the core business, the 90%, 95% of
the business that is Oncology, those ARs are improving and that issue is solving itself, and
maybe we’d feel incrementally better on that.
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Elisha W. Finney: Absolutely, and I think the first thing to make you feel good is, again,
Oncology DSO down 10 days, quarter-over-quarter and…
Jeff Johnson: Yes.
Elisha W. Finney: …roughly flat with Q1. So, I think we’ve started to stabilize.
Jeff Johnson: Yes. It would just be good if we could have those numbers and kind of play with
them ourselves. But I appreciate it. Thank you.
Elisha W. Finney: Yes. Okay.
Operator: There are no further questions over the audio portion of the conference. I’d now
like to turn the conference back over to Management for closing remarks.
Spencer R. Sias: Thank you, all, for participating. The replay of this call can be heard on the
Varian investor website at www.varian.com/investor where it will be archived for a year. To
hear a telephone replay, please dial 1-877-660-6853 from inside the US or 1-201-612-7415 from
Varian Medical Systems Second Quarter FY2017 Earnings Results Conference Call
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outside the US, and enter in confirmation code 13658758. The telephone replay will be
available through 5 PM this Friday, April 28, 2017. Thank you.
Operator: This concludes today’s conference. Thank you for your participation. You may
disconnect your lines at this time. Have a wonderful rest of your day.