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Varian (VAR) Beats Q2 Earnings by a Penny, Lags Revenues

Varian Medical Systems Inc. VAR reported earnings of $1.09 per share in the second quarter of fiscal 2016, which beat the Zacks Consensus Estimate by a penny but remained flat on a year-over-year basis. The figure was toward the higher end of management’s guided range of $1.06-$1.10 per share.
 

Revenues remained flat at $758.8 million but lagged the Zacks Consensus Estimate of $772 million and also missed the company’s guided range of 1%–2% growth. At constant currency (cc), revenues improved 2% from the year-ago quarter.

Segment Details

Varian reported backlog of $3.3 billion at the end of the second quarter, up 6% on a year-over-year basis.

Oncology System sales decreased almost 1% (up 1% at cc) from the year-ago quarter to $584.1 million, while gross orders increased     6.3% (up 8% at cc) to $617.8 million in the quarter.

Gross orders increased 2% (up 3% at cc) in Americas. Orders in North America grew 7% year over year, which fully offset a decline in Latin America. The growth in North America can be attributed to higher demand for newer products like VitalBeam accelerator as well as RapidPlan and InSightive analytics software for improving clinical efficiency.

During the quarter, the MD Anderson cancer center ordered six TrueBeam systems. The company also won a couple of large deals in Canada. However, weakness in Brazil hurt sales growth in Latin America.

Meanwhile, the company announced collaboration with several cancer treatment centers in Brazil for the training of healthcare professionals on advanced radiotherapy technologies.

In the EMEA region, gross orders were up 19% (up 23% at cc) driven by big wins in India and the Middle East. India-based Apollo Hospital Group ordered 12 high-end linear accelerators and five brachytherapy systems. The company also booked several orders in the Middle East, including systems for four new sites in Turkey.

In the APAC region, gross orders were up 2% (3% at cc) driven by robust growth in China. More than 75% of the Varian linear accelerators ordered in the quarter in the country were for new treatment vault. The company also won a large contract in Indonesia.

Varian noted that RapidPlan is now installed at nearly 170 sites around the world. The company also received multiple orders for InSightive analytics. Total orders for the software has increased to 80 since its launch earlier this fiscal.

The Christie Hospital in Manchester, England, also ordered several software products, including Eclipse Treatment Planning for protons and Velocity product that uses images to track tumor responses for treatment.

Imaging Components (comprising X-Ray Products and Security, and Inspection Products) revenues fell 7.6% on a year-over-year basis to $143.7 million. The decline was primarily due to decreases in tubes, panels, and security and inspection products.

Imaging Components gross orders deteriorated 11.8% to $137.9 million. The ongoing sale of Toshiba’s tube business to Canon is expected to weigh on growth in the near term. However, Varian believes that challenges are now waning and the segment will stabilize in the near future. The company’s new MeVis and Claymount businesses performed well in the quarter. Management continues to believe that these businesses will generate about $50 million in revenues in fiscal 2016.

During the quarter, Varian opened a regional service center at the Jiangsu province in China. The service center will produce and repair key imaging components for X-ray equipment.

The service center in Wuxi has a floor area of 3700 square meter and is capable of manufacturing 2,000 tubes and 800 panels a year. Varian will operate two X-ray tube production lines and one repair and service center for flat panel detectors.

The service center along with the Beijing center will effectively serve Chinese clients, who will no longer depend on service centers outside China to repair tubes and flat panel detectors.

Other segment (which includes Varian Particle Therapy business and the Ginzton Technology Center) revenues surged 113.8% to $31 million. However, gross orders plunged 93.9% to $2.7 million.

Operational Details

Gross margin contracted 70 basis points (bps) on a year-over-year basis to 41.8%, primarily due to unfavorable product mix.

Research & development expenses (R&D), as percentage of revenues, increased 40 bps to 8.2%, while selling, general and administrative expenses (SG&A) were up 50 bps to 16% in the quarter.

As a result, operating margin contracted 90 bps on a year-over-year basis to 19.1%.

Outlook

For fiscal 2016, Varian reiterated adjusted earnings in the range of $4.55–$4.65 per share. Revenues are now expected to increase by 3%, down from the range of 4%–5%.

For the third quarter of fiscal 2016, revenues are expected to remain flat with the year-ago quarter level. Adjusted earnings are projected in the band of $1.16–$1.20.

Our Take

Varian provided a decent third quarter and fiscal-year 2016 guidance. Foreign exchange rate did not majorly affected results in the second quarter (per management maximum 2 cents of impact) and is expected to mellow down over the remaining of fiscal 2016, which will bring relief for management.

Oncology business growth prospects remain impressive. The company is addressing both the tier 1 and mid-tier markets through its Edge, Truebeam and VitalBeam products. The company is also winning contracts, not only in the Americas but also in the international markets, which is a huge positive.

We believe China, India, Brazil (despite weak showing in the second quarter), the Middle-East and Africa present significant top-line growth opportunity to Varian. The company is opening up new offices in Africa and the Middle East, which shows that it is aware of the growth opportunities in the region.

Moreover, Varian’s strong product pipeline is a key growth catalyst. The company believes that the Proton system has massive growth opportunities despite a smaller financing base. Varian noted that growing governmental spending will reduce financing problems related to Proton therapy systems over the long haul. Moreover, growing demand for smaller units is a positive for the system.

Nevertheless, increasing local competition is the primary headwind. The weakness in the Imaging Components business is also a concern, at least in the near term.

Zacks Rank & Key Picks

Currently, Varian carries a Zacks Rank #2 (Buy).

Other well-placed stocks in the medical sector are RTI Surgical RTIX, Exactech EXAC and Inogen INGN. While RTI Surgical sports a Zacks Rank #1 (Strong Buy), both Exactech and Inogen carry a Zacks Rank #2 (Buy).

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VARIAN MEDICAL (VAR): Free Stock Analysis Report
 
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