Varian Medical Systems Inc
Q2 2017 Earnings Call Transcript

Published: 27 Apr 2017

[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. 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 we'll take your questions following the presentation. To simplify our discussion, unless otherwise stated, all references to 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 is 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 statements are subject to risks and uncertainties that could cause actual results to differ materially. Some of these important risks related to our business are described in our second quarter earnings 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 am 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 have 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 developments 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. 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% constant currency, bringing year-to-date orders growth to 7% in dollars and constant currency; and a $26 million equipment order for a single-room 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 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 CHUL (5

[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 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. 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 1-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 U.K. 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 year-ago 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 lower proton gross 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 $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 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. Primary uses of cash were $173 million toward the repurchase of 2 million shares of stock and $15 million for CapEx. 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 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 will 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 receivables in the first quarter. For the third fiscal 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 have 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, 70-plus quarters together, what's the exact count?

[Elisha W. Finney:]

73.

[Dow R. Wilson:]

73 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 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. 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 interject a quick correction. We talked about the Investor Meeting next week at the New York Stock Exchange. It is on May 10th, 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 10th. And we'll now open for questions.

[Operator:]

Thank you. At this time we will be conducting a question-and-answer session. Our first question comes from the line of Jeff Johnson of Robert W. Baird. Please proceed with your question.

[Jeff D. 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 don't know.

[Elisha W. Finney:]

Thank you, Jeff.

[Jeff D. Johnson:]

And 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 D. Johnson:]

So a couple of questions, Dow, first just on guidance. You came in at revenue wise above kind of the three-quarter guidance that you've been providing. You came 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 $0.10 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:]

Yeah Elisha, go ahead.

[Elisha W. Finney:]

Yeah. 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 – 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 out 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 protons, 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 $1 million or $2 million high, but within our expectations. So we simply raised the midpoint at this point in the quarter from $3.00 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 the shoring up of the bottom end of the revenue guidance.

[Elisha W. Finney:]

Yes.

[Jeff D. 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 the balance sheet risk with that, I think one of the explanations was you had to get a win on the board and if you had to put the 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 of 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 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 is 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 did view this segment as 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.

[Jeff D. Johnson:]

Thank you.

[Dow R. Wilson:]

Yeah. 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 6 to 12 months. I mean at the high end, three. So it's not going to be, we 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 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.

[Amit Hazan:]

So let me just actually start with orders first and go to the U.S. 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 U.S. 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 U.S. 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-digit and we were very pleased about that. I'd say, no real difference in the U.S. market.

[Amit Hazan:]

Okay. And then maybe let me jump to cash flow actually. So thinking about it in 2016, this came up a few times, free cash flow was down a lot, like 25% or so I think in 2016. Free cash flow conversion used to be really strong in the 80%s 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.

[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:]

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. So, I think in your pro forma numbers that you guys filed, it looked like your operating margin is kind of as Varian as a standalone post – without the spin or after the spin is about 18% in fiscal 2016. I think you're talking about 18% to 19% for this year. It sounds like this was a onetime 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 operating margin line for the rest of the year?

[Elisha W. Finney:]

You're absolutely right. I mean, once you pencil this out, you will see pro forma 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.

[Anthony Petrone:]

Great. And congratulations again, Elisha and Dow (sic) [Spencer] (32

[Elisha W. Finney:]

So Anthony, just to clarify. 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.

[Anthony Petrone:]

And 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 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 to, 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 will 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 proton-related 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 JPMorgan 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.

[Anthony Petrone:]

Thanks.

[Operator:]

Our next question comes from the line of Tycho Peterson of JPMorgan. Please proceed with your question.

[Tycho W. Peterson:]

Dow I'm wondering if you could, and congrats to Elisha and Spencer. Dow I'm wondering if comment on pricing dynamics. You talked about the12 competitive wins in the U.S. 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 are 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 U.S. market continues to be pretty good. Other America's activity, it can be aggressive from time to time. But in the U.S., the pricing environment has been pretty stable.

[Tycho W. Peterson:]

I know you talked about the U.S holding up. I mean the data points from GE, Philips and some of the others has 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 W. 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 W. Peterson:]

And 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?

[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 both in patients. And that's kind of the, when you think of it in market needs, 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 W. Peterson:]

All right. And then just last one maybe for Elisha on the revised profitability estimate on the U.K. project, that was all due to currency? Or were there any adjustments around utilization assumptions?

[Elisha W. Finney:]

It's largely currency Tycho, just the pound being at a historical low.

[Tycho W. Peterson:]

Okay. Thank you.

[Operator:]

Our next question comes from the line of Brandon Henry of RBC Capital Markets. Please proceed with your question.

[Brandon Henry:]

Yeah. 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% and while 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 revenue. So I think we're making good progress. Remember on this cash flow from operations, again significant transaction cost included in those numbers.

[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 2017. Are there any details you can give us regarding this product, what features or margin profile it may have and then what geographies you are going to target for this launch?

[Dow R. Wilson:]

I mean (42

[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 a leadership position now in China. So we're comfortable that the share is going in the right direction. And the whole market – I wouldn't get – yeah, there are category A, category B issues. But we got to watch the whole market here, and the whole market is moving. And as I said in the script, we are 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 weeks, it's going to require – it'll 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?

[Dow R. Wilson:]

Well.

[Vijay Kumar:]

Elisha, again, I wish you all the best for your next chapter, you too Spencer. And maybe, on, I guess, the guidance, so revenue is down by 100 bps and EPS up at the low end. Can you just, explain or walk me through on what changed between the revenue line and the EPS?

[Elisha W. Finney:]

Yeah. 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. 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 1-point 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 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 include 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 billion. We are now at $3.136 billion. So you're right, a couple of hundred million dollars 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, either on the P&L and the backlog? I guess a part of the issue is, when I try to look back, 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 will be really helpful for us. 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 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, 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 a 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 installed 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 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 coformality 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:]

We have a follow-up question from the line of Anthony Petrone. Please proceed with your follow-up.

[Anthony Petrone:]

Thanks Dow. Maybe just on the regulatory pathway for the system and timing there, and if this is included in guidance at all. Thanks.

[Dow R. Wilson:]

The short version is I'll talk to you in two weeks. I mean I think we've got a very exciting product. It's, from a guidance point of view, very minimal. It's, we are 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 FY 2018 on the revenue side...

[Dow R. Wilson:]

On the P&L side.

[Elisha W. Finney:]

On the P&L side. Yeah.

[Anthony Petrone:]

Yeah. 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 D. Johnson:]

Thanks. Elisha just quickly...

[Dow R. Wilson:]

Hey, Jeff.

[Jeff D. Johnson:]

Hey, Dow, so just very quickly, is there a way can provide us with just accounts receivable number, maybe over the last couple of years in 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 D. Johnson:]

Yeah. On a go forward basis or maybe you could post at some point on the website.

[Elisha W. Finney:]

Sure.

[Jeff D. Johnson:]

Yeah. 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 can see on the core business, the 90%, 95% of the business that is Oncology, those ARs are improving, that issue is solving itself, and maybe we'd feel incrementally better on that.

[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 roughly flat with Q1. So I think we've started to stabilize.

[Jeff D. Johnson:]

Yeah. It would be 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:]

Yeah. 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 U.S., or 1-201-612-7415 from outside the U.S., and entering confirmation code 1365-8758. The telephone replay will be available through 5 p.m. 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.