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Reiterates revenue guidance; Raises EPS outlook. Management reiterated their previously issued F11 outlook
calling for revenues to grow ~10%-11% yr/yr (translating to roughly $2,590M-$2,620M). The company raised EPS
guidance to $3.39-$3.45, from a prior range of $3.34-$3.39, which largely reflects this past quarter's upside. Current
F11 consensus estimates call for revenues to grow ~10% yr/yr to $2,587.7M and EPS to grow ~14% yr/yr to $3.38.
While order weakness could result in concerns over revenue growth, we are confident in VAR's ability to generate
top-line growth for the year within its stated range. At the same time, we believe that F11 EPS guidance reflects a
health degree of conservatism as it appears to us that the company's GM story is manifesting itself quicker than
expectations even without a significant trueBEAM P&L impact (~30% of orders, though only ~5% of revenues).
Additional quarterly highlights. Total net orders came in at $592.8M in the quarter, which was up 20% yr/yr. VAR's
backlog at the end of the quarter was up 10% yr/yr to $2.2B. WW oncology revenues orders were $459M (+5%
reported; +6% cc), coming in below consensus expectations of roughly $484M due to aforementioned weakness in
Japan which experienced an approximate $40M decline in revenue on a yr/yr basis. During FQ1:11, VAR went up
against a very tough comp with ~$65M of Japan-related revenue recognized in FQ1:10 vs. ~$22M recognized n
FQ1:11. As the radiotherapy stimulus ended in March 2010, we expect another fairly challenging comp for FQ2:11, but
not nearly to the magnitude we saw this past quarter. International oncology order growth was down ~6% yr/yr after
being +7% last quarter. In addition to weakness in Japan, European order growth was impacted by a stronger dollar
(cc growth in Europe was 17%). International oncology orders ex-Japan were up ~17% yr/yr. North American order
growth remains impressive coming at ~20% in FQ1:11. This was the fourth consecutive quarter of double-digit new
order oncology growth, with three successive quarters of such growth in North America. Oncology revenues benefited
from continued strength in trueBEAM and we believe that the vast majority of related orders represented new orders
vs. upgrades from backlog – a trend that is expected to continue. X-ray revenues came in at $111.6M (+22% yr/yr) and
related orders came in at $111.9M (+13% yr/yr) with management citing higher demand for both X-ray tubes and flat
panel detectors.
Gross margins of 46% in the quarter came in well ahead of our 43.7% estimate and were up 140 bps yr/yr driven by
strength in both Oncology (47.3%) due to higher trueBEAM revenues and X-ray (42.3%) owed to strength in tubes.
Notably, oncology GMs rebounded from last quarter's disappointing print. Management announced on the call that it
had secured an additional three-year contract with Toshiba Medical Systems valued at ~$450M, reflecting roughly a
40% increase in value over the company's prior three-year contract with Toshiba. During the quarter, VAR generated
$138M in cash from operations, with management citing better receivables collections. The company's effective tax
rate during the quarter came in at 29.6% which was ~100 bps lower than management's forecast due to the
reinstatement of the R&D tax credit. For F11, management forecasts an effective tax rate of 31%-32%.
trueBEAM ramp continues. Although total trueBEAM orders of ~45 were down q/q from 60, we attribute this to typical
seasonality, and see no change in underlying demand for the product. During the quarter, trueBEAM accounted for
30% of global unit orders (including the majority of N.A. orders), though continues to represent only ~5% of revenues.
Management indicated that there are ~40 installations that have either been completed or are in progress. We believe
that VAR's trueBEAM platform represents a paradigm shift in radiation oncology treatment that should continue to
boost new order levels going forward. Since the April launch of VAR's trueBEAM system, orders have ramped well
ahead of our expectations, and management noted that they are very pleased with adoption trends thus far. VAR's
trueBEAM platform (170 reported orders to date) and upgrade capabilities should continue to boost new order levels
going forward.
More color around F11 outlook. Management reiterated their previously issued F11 outlook calling for revenues to
grow ~10%-11% yr/yr (translating to roughly $2,590M-$2,620M). The company raised EPS guidance to $3.39-$3.45,
from a prior range of $3.34-$3.39, which largely reflects this past quarter's upside. Current F11 consensus estimates
call for revenues to grow ~10% yr/yr to $2,587.7M and EPS to grow ~14% yr/yr to $3.38. Aided by relatively easy
In F11, the company now forecasts GMs to rise ~100 bps, up from a prior forecast of 50 bps (driven by higher ASP
trueBEAM systems), with SG&A and R&D each expected to be up slightly as a percentage of sales, contributing to
overall operating leverage of ~50 bps for F11. We believe that F11 EPS guidance reflects a health degree of
conservatism (consistent with the company's managing of Street expectations) as it appears to us that the company's
GM story is manifesting itself quicker than expectations even without a significant trueBEAM P&L impact. We expect
trueBEAM to drive GM expansion going forward offsetting any margin compression from international systems
installation mix shift while continued mix shift to flat panel detectors will drive margins for the X-ray business.
Management issued FQ2:11 guidance for revenue growth of ~9%-10%, which is roughly in line with the Street at ~9%,
and EPS of $0.83-$0.86, which compares to the Street at $0.84.
Numerous positive catalysts provide solid runway for VAR through 2011 and beyond. We believe that Varian's
sales funnel is as strong as it has ever been due to its new product platform and the promise of technological
advancements that will provide increased clinical efficacy in the future. We see numerous catalysts in 2011 for VAR
including 1) Continued accelerated adoption of trueBEAM and trueBEAM STx platforms bolstering new oncology order
growth, top and bottom line outperformance; 2) Proton system orders expected in 2011; 3) quarterly earnings
performances; 4) ASTRO 2011 in Miami; 5) Further development of SRS capabilities (i.e. integration of RapidArc into
SRS treatment algorithms). We believe that the free standing center market, which just began to meaningfully rebound
in FQ4 from the proposed reimbursement schedule last summer, could provide an additional layer of growth for U.S.
orders into F11. Our checks at ASTRO indicate that the trueBEAM funnel in N.A. looks positive and we are encouraged
by the recent pick-up in activity in the U.S. and the relatively easy N.A. comps for 1H:11. Further, although international
orders face more difficult comps, and more recent concerns regarding the impact of austerity measures in Europe
(issues raised in recent quarterly Q4 reports from GE and Philips), international oncology orders ex-Japan were up
~17% yr/yr. Moreover, we believe that VAR's push into new geographies could offset any near-term headwinds from
Europe, as we expect the UNIQUE system to provide VAR access to emerging markets in need of discounted
purchase prices including China.
Adjusting F11 and F12 estimates. Based on the company's F1Q:11 financial results, management's F11 outlook and
our growth expectations for the radiation oncology market, we are adjusting our forward revenue and EPS estimates.
We are adjusting our F11 revenue and EPS estimates to $2,600M and $3.45, from $2,620M and $3.40. Our revised
estimates correspond to revenue and EPS growth of 10% and 16%, respectively. Our new F11 estimates continue to
reside above the current consensus of $2,588M (+10% yr/yr) and $3.38 (+14% yr/yr). During F1Q:11, VAR did not
repurchase any stock outside of the accelerated share repurchase executed in August and anticipated to be completed
by late-February. We believe that the accelerated stock repurchase can support at least $0.05 of accretion in F11,
which is reflected in our estimates. We note that the company has ~4.5M shares authorized for additional repurchase
through F11. In addition, we are adjusting our F12 revenue and EPS estimates to $2,870M and $3.95, from $2,857M
and $3.90, which reflects yr/yr growth of 10% and 14%, respectively, and are above current consensus estimates of
$2,808M (+8.5% yr/yr) and $3.81 (+13% yr/yr).
Raising PT. Our new $84 price target (previously $71) is a blended avg. of: 1) a C12 20.5x P/E, 2) a C12 8x
EV/EBIDTA, and 3) a 10 yr. DCF. Although VAR's valuation may appear rich (~23x C11 EPS), we see VAR as one of
the cleaner MedTech stories in C11 with numerous catalysts, GM expansion and continued upside to Street EPS
estimates. We believe that consistent reliable top- and bottom-line growth stories deserve premium multiples.
Company Description
Varian Medical Systems, headquartered in Palo Alto, California, is the leading provider of integrated systems for
treating cancer with radiation therapy and is one of the premier suppliers of X-ray tubes for diagnostic imaging
applications. The company sells through a direct sales force of 50 reps in the U.S. and through a combination of direct
sales and independent distributors internationally. In April 1999, the company (then known as Varian Associates, Inc.)
spun off its instruments business and its semiconductor equipment business to stockholders as separate companies.
The original company retained the medical systems business and changed its name to Varian Medical Systems, Inc.
Year Ending Sep 2010 (FY10) Year Ending Sep 2011 (FY11) Year Ending Sep 2012 (FY12)
FQ1 FQ2 FQ3 FQ4 FY10 CY10 FQ1 FQ2E FQ3E FQ4E FY11E CY11E FQ1E FQ2E FQ3E FQ4E FY12E
Revenue $540.9 $585.6 $578.0 $652.1 $2,356.6 $2,395.6 $579.9 $643.4 $645.8 $730.9 $2,600.0 $2,646 $625.9 $709.7 $720.1 $814.3 $2,870.0
Cost of Goods Sold 299.9 331.6 323.6 375.9 1,331.0 1,344.2 313.1 354.2 353.9 401.4 1,422.6 1,448.9 339.3 385.7 389.0 439.1 1,553.2
Gross Profit 241.0 254.0 254.4 276.2 1,025.6 1,051.4 266.8 289.1 291.9 329.6 1,177.3 1,197.1 286.5 324.0 331.2 375.2 1,316.8
R&D 38.4 38.9 38.9 40.5 156.7 156.8 38.5 43.7 43.9 48.2 174.4 178.5 42.6 48.3 48.2 54.6 193.6
SG&A 83.5 79.6 84.7 86.9 334.7 342.5 91.3 99.1 97.5 109.6 397.5 400.1 93.9 105.0 105.1 118.1 422.1
Operating Income 119.1 135.5 130.8 148.8 534.2 552.1 137.0 146.3 150.5 171.7 605.4 618.5 150.1 170.7 177.8 202.6 701.1
Interest (Income) 0.0 0.3 0.9 (0.2) 1.0 0.9 (0.1) (0.7) (0.8) (0.8) (2.4) (3.1) (0.8) (0.7) (0.8) (0.8) (3.1)
Interest Expense 0.3 0.0 0.0 0.0 0.3 0.0 0.0 1.0 1.1 1.1 3.2 4.3 1.1 1.0 1.1 1.1 4.3
Pretax Income 118.8 135.2 129.9 149.0 532.9 551.2 137.1 146.0 150.2 171.4 607.8 617.3 149.8 170.4 177.5 202.3 704.2
Taxes 40.0 44.1 38.0 43.3 165.4 166.0 40.6 45.3 46.6 53.1 185.5 191.4 46.4 52.8 55.0 62.7 217.0
GAAP Net Income 76.3 91.1 91.9 105.7 365.0 385.2 96.5 100.7 103.6 118.3 419.1 425.9 103.3 117.6 122.5 139.6 482.9
Stock Based Comp Expense (Tax effected) 7.4 7.6 6.9 7.0 28.9 28.6 7.1 7.3 7.5 7.7 29.6 30.6 8.1 8.3 8.5 8.7 33.6
Pro Forma Net Income 78.8 91.1 91.9 105.7 367.5 385.2 96.5 100.7 103.6 118.3 419.1 425.9 103.3 117.6 122.5 139.6 482.9
Diluted Shares (MM) 125.1 124.3 124.5 121.4 123.8 122.9 121.2 121.4 121.6 121.8 121.5 121.7 122.0 122.2 122.4 122.6 122.3
Pro Forma EPS $0.63 $0.73 $0.74 $0.87 $2.97 $3.14 $0.80 $0.83 $0.85 $0.97 $3.45 $3.50 $0.85 $0.96 $1.00 $1.14 $3.95
After-Tax "One" Time Charges 2.5 0.0 0.0 0.0 2.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
GAAP EPS $0.61 $0.73 $0.74 $0.87 $2.95 $3.14 $0.80 $0.83 $0.85 $0.97 $3.45 $3.50 $0.85 $0.96 $1.00 $1.14 $3.95
Fully Taxed Cash Net Income 86.2 98.7 98.8 112.7 396.4 413.8 103.6 108.0 111.1 126.0 448.7 456.5 111.4 125.9 131.0 148.3 516.5
Cash EPS ex-SBC, one timers $0.69 $0.79 $0.79 $0.93 $3.20 $3.37 $0.85 $0.89 $0.91 $1.03 $3.69 $3.75 $0.91 $1.03 $1.07 $1.21 $4.22
Margin Analysis
Gross Profit 44.6% 43.4% 44.0% 42.4% 43.5% 46.0% 44.9% 45.2% 45.1% 45.3% 45.8% 45.6% 46.0% 46.1% 45.9%
R&D 7.1% 6.6% 6.7% 6.2% 6.6% 6.6% 6.8% 6.8% 6.6% 6.7% 6.8% 6.8% 6.7% 6.7% 6.7%
SG&A 15.4% 13.6% 14.7% 13.3% 14.2% 15.7% 15.4% 15.1% 15.0% 15.3% 15.0% 14.8% 14.6% 14.5% 14.7%
Operating Income 22.0% 23.1% 22.6% 22.8% 22.7% 23.6% 22.7% 23.3% 23.5% 23.3% 24.0% 24.0% 24.7% 24.9% 24.4%
Pretax Income 22.0% 23.1% 22.5% 22.8% 22.6% 23.6% 22.7% 23.3% 23.4% 23.4% 23.9% 24.0% 24.6% 24.8% 24.5%
Net Income 14.1% 15.6% 15.9% 16.2% 15.5% 16.6% 15.7% 16.0% 16.2% 16.1% 16.5% 16.6% 17.0% 17.1% 16.8%
Tax Rate 33.7% 32.6% 29.3% 29.1% 31.0% 29.6% 31.0% 31.0% 31.0% 30.5% 31.0% 31.0% 31.0% 31.0% 30.8%
Growth Analysis
Total Revenue 6% 6% 13% 2% 6% 7% 10% 12% 12% 10% 8% 10% 12% 11% 10%
Gross Profit 10% 6% 18% -3% 7% 11% 14% 15% 19% 15% 7% 12% 13% 14% 12%
R&D 4% 5% 10% 6% 6% 0% 12% 13% 19% 11% 11% 10% 10% 13% 11%
SG&A 0% -2% 8% -10% -1% 9% 24% 15% 26% 19% 3% 6% 8% 8% 6%
Operating Income 21% 11% 28% -1% 13% 15% 8% 15% 15% 13% 10% 17% 18% 18% 16%
Pretax Income 19% 11% 27% -1% 11% 15% 8% 16% 15% 14% 9% 17% 18% 18% 16%
Net Income 11% 34% 8% 9% 14% 26% 11% 13% 12% 15% 7% 17% 18% 18% 15%
Pro Forma EPS 13% 15% 8% 12% 12% 26% 13% 15% 12% 16% 6% 16% 17% 17% 14%
Margin Analysis
Gross Profit 42.9% 41.5% 41.3% 41.7% 43.4% 43.5% 45.3% 45.9%
R&D 5.9% 6.3% 6.6% 6.5% 6.7% 6.6% 6.7% 6.7%
SG&A 14.9% 15.9% 15.9% 15.6% 15.3% 14.2% 15.3% 14.7%
Operating Income 22.1% 19.4% 18.9% 19.5% 21.4% 22.7% 23.3% 24.4%
Pretax Income 22.6% 20.2% 19.6% 20.1% 21.6% 22.6% 23.4% 24.5%
Net Income 13.3% 14.0% 13.5% 14.0% 15.0% 15.6% 16.1% 16.8%
Tax Rate 32.5% 23.2% 29.7% 31.2% 29.9% 31.0% 30.5% 30.8%
Growth Analysis
Total Revenue 16% 11% 17% 6% 6% 10% 10%
Gross Profit 12% 11% 18% 10% 7% 15% 12%
R&D 22% 17% 16% 8% 6% 11% 11%
SG&A 23% 11% 16% 4% -1% 19% 6%
Operating Income 3% 7% 20% 14% 11% 14% 16%
Pretax Income 22% 7% 22% 14% 11% 14% 15%
Net Income 22% 7% 22% 14% 11% 14% 15%
Pro Forma EPS 25% 11% 25% 16% 12% 16% 14%
ANALYST CERTIFICATIONS
I, Joshua Jennings, M.D., certify that all of the views expressed in this research report accurately reflect my personal
views about the subject security(ies) and subject company(ies). I also certify that no part of my compensation was, is,
or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.
I, Anthony Petrone, CFA, certify that all of the views expressed in this research report accurately reflect my personal
views about the subject security(ies) and subject company(ies). I also certify that no part of my compensation was, is,
or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.
I, Matthew Weiss, CFA, certify that all of the views expressed in this research report accurately reflect my personal
views about the subject security(ies) and subject company(ies). I also certify that no part of my compensation was, is,
or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.
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Valuation Methodology
Jefferies' methodology for assigning ratings may include the following: market capitalization, maturity, growth/value,
volatility and expected total return over the next 12 months. The price targets are based on several methodologies,
which may include, but are not restricted to, analyses of market risk, growth rate, revenue stream, discounted cash flow
(DCF), EBITDA, EPS, cash flow (CF), free cash flow (FCF), EV/EBITDA, P/E, PE/growth, P/CF, P/FCF, premium
(discount)/average group EV/EBITDA, premium (discount)/average group P/E, sum of the parts, net asset value,
Rating and Price Target History for: Varian Medical Systems, Inc. (VAR) as of 01-25-2011
75
60
45
30
15
Q1 Q2 Q3 Q1 Q2 Q3 Q1 Q2 Q3 Q1
2008 2009 2010 2011
Created by BlueMatrix
Distribution of Ratings
IB Serv./Past 12 Mos.
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