Varian Medical Systems Inc
Q4 2016 Earnings Call Transcript

Published: 27 Oct 2016

[Operator:]

Greetings, and welcome to the Varian Medical Systems Fourth Quarter 2016 Earnings Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Spencer Sias, Vice President. Please go ahead sir.

[Spencer Sias:]

Thank you. Good afternoon and welcome to Varian Medical Systems’ conference call for the fourth quarter of fiscal year 2016. With me are Dow Wilson, President and CEO, Elisha Finney, CFO, and Clarence Verhoef, our Corporate Controller. Dow and Elisha will summarize our results and we will take your questions following the presentation. This is, 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 fourth quarter of fiscal 2016 versus the fourth quarter of fiscal 2015. 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 comparison and operation of performance excluding unusual items. A reconciliation to the most comparable GAAP measure 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 represents 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 the important risks relating to our business are described in our fourth 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. And now, here is Dow.

[Dow Wilson:]

Good afternoon and welcome. Our company finished fiscal year 2016 on a positive note with healthy fourth quarter and revenue and significant margin improvement in both our Oncology and Imaging Components businesses. Orders in the Oncology and Proton businesses on the other hand were down during the quarter versus tough year ago comparisons in which we had record setting Oncology growth in Western Europe and in our Proton business. To summarize, our fourth quarter results for fiscal 2016 we are reporting, GAAP net earnings of the $1.24 per diluted share, up from $0.99 from the year ago quarter. Non-GAAP net earnings of the $1.38 per diluted share, up more than 30% from the $1.04 in the year ago quarter. A decline in Oncology orders due to weakness in Western Europe. Revenues of $912 million up 12% in dollars and up 11% in constant currency and gains of about four percentage points in our gross margins the significant improvements in both our major businesses. Focusing on Oncology operations, orders totaled $897 million for the fourth quarter, down 2% in dollars and down 4% in constant currency versus a strong year ago quarter. Orders for the year totaled $2.7 billion, up 1% from the prior year and up 2% in constant currency. Fourth quarter orders in the Americas grew by 4% in dollars and increase by 3% in constant currency. For the year, orders in Americas were up 4% in both dollars and constant currency. In North America, orders fell by 2% in the fourth quarter but grew by 5% for the year ahead of our expectations for these markets. Fourth quarter Oncology orders in APAC rose by 8% in dollars and fell by 1% in constant currency. For the full-year, APAC orders rose by 5% in dollars and by 3% in constant currency. In EMEA, Oncology orders declined by 17% in dollars and in constant currency principally because of weakness in Western Europe where we had exceptional strong growth in a year ago quarter when we set a record by booking orders for more than a 100 escalators. For the year, orders in EMEA were down 6% in dollars and down 4% in constant currency driven by weakness in Western Europe. Comparing revenues on a trailing 12 months basis, we believe we gain market share versus our primary competition. Our average selling price rose with the help of higher mix of TrueBeam and VitalBeam orders. We generated solid order growth during the quarter in emerging markets including Brazil, Africa and in the Middle East. In Brazil, we booked nearly $30 million of new business including a big win at Grupo Oncoclinicas, where we will be installing 13 TrueBeam and VitalBeam accelerators as well as software to support clinical operations. These will be the first VitalBeam accelerators installed in Latin America. Columbia was also a strong contributor to robust order growth in the quarter. Total orders in Latin America exceeded $60 million during the quarter, up more than 70% from the prior year period. Other emerging markets contributing to Oncology orders during the quarter included Africa was about $20 million and the Middle East where we booked more than $40 million and as an example of progress, we received $14 million order for a eight escalators at the Shifa International Hospital in Islamabad. In APAC emerging markets, we have generated healthy order growth in Indonesia, Korea and the Philippines, in those markets particularly Japan also contributed to the order growth in this region. Meanwhile, orders in greater China were down from a year ago period in part because of continuing tender protest, while we anniversary the effects of these multiple order and while we are retaining the book of the business that we won. We estimate that orders in China in a fiscal year could have been more than 15 million higher without this protest activity. Turning to North America, we established significant new three-year strategic agreement with McKesson Specialty Health to supply its U.S. Oncology Advantage Cancer Treatment networks with equipment software and services. In the first phase, we will be equipping centers with seven TrueBeam and five VitalBeam accelerators. We also will be working to establish in our interoperability with Varian’s Information Management and McKesson’s iKnowMed G2 clinical oncology sector. We see an opportunity here to support these networks with more of Eclipse, ARIA, Velocity and new 360 Oncology software. Overall, we had a very good year in North America, where we had in excess of $130 million in take out of more than 40 accelerators and nearly 100 software installations from competitors. As you now, we have just return from ASTRO in Boston, it was a great show for us with some 900 attendees at our users meeting numerous customers for emerging markets and very positive response to several major new products that we will be bringing to market this year. We introduce 360 Oncology a first of its kind of software tool that enable clinicians on tumor boards to more effectively coordinate patient care among the numerous specialist involved in cancer treatment. This software also provides patients with the clear picture of how the many elements involved and treating their cancer fit together. Customer responses enthusiastic and we believe, we have winning product on our hands. We also showed our progress in the development of our HyperArc technology for automating and simplifying the delivery of stereotactic radiosurgery with more compact dose distributions and better protection of surrounding healthy tissue. We are aiming reduces important upgrade to our TrueBeam and Edge platform this year beginning with the module for treating head neck cancers. Oncology administrators were also very interested in our initiatives in which we will be enhancing the security embedded within Varian Software Systems. We believe, we have a leading position in the development of this important new capability and we expect it could generate an additional $80 million in revenues by the end of fiscal year 2018. We have continued to see a very positive market response to our rapid plan and insight of analytics software products that help to improve the speed, quality and cost efficiency treatments. We have taken more than 650 orders or rapid plans since its launch and more than 135 orders for our insight of software. Touching on the service business global revenues rose by 7% during the quarter with gains in all geographies. Turning now to our Particle Therapy business, we generated $38 million in orders during the fourth quarter bringing total orders for the year to $104 million. Orders were down significantly from fiscal 2015, when we had a total of fixed system orders including an $87 million order for our ProBeam System at University of Maryland. Revenues from 14 ongoing projects grew nicely reaching $68 million in the fourth quarter and bringing total revenues for the year to $163 million including about $10 million in annual service revenues. During the fourth quarter, we booked our first single room ProBeam compact order marketing important milestone for the business. This new system will be installed that the Advanced Medicine Training Center in Singapore, where Varian loss provide Eclipse treatment planning system. We also have a 10-year agreement to service the system. Also during the quarter, the UK University, Collage London Hospital placed an order for our fourth treatment gantry at the Proton Therapy Center that is currently under construction. Earlier this month, treatment commenced using our ProBeam System at Cincinnati Children's Hospital making it the fifth Varian equipped Proton center to treat clinically. At this point, the Proton sales funnel looks healthy and I’m pleased by the progress we are making. Let me turn now to imaging components. Recovery in this business continued in the fourth quarter. Orders grew by 2% to $168 million fourth quarter resulting in 7% orders growth for the last six months. Orders for the year totaled $571 million down 6% from the prior year because of first half headwinds including significant purchasing slowdowns at two major customers. Revenues were up 7% for the fourth quarter and down 2% for the year. Our Memphis and Claymount acquisitions as well successful efforts to develop business with new customers contributed Imaging Components order and revenue growth during the quarter. Great cost control as well as a favorable product mix in tubes and fat panel Imaging detector and higher volumes in our security and inspection line enabled the Imaging business to achieve a significant gain in its gross margin for the quarter. Looking at operational highlights for the whole year. The Imaging Components business introduced 20 new products completed a 140,000 square foot expansion of this manufacturing facility and Salt Lake City. Opened a new facility in China to service drawing customer base there, successfully integrated and mobilized its Memphis and Claymount acquisitions added 12 new customers to offset slower purchasing from established customers and exceeded its profit targets. We are proud of this performance and we expect Imaging Components to be a great company that deliver solid returns on a separates from Varian and is established as Varex Imaging an independent publicly traded company. Work on the separation continues to go smoothly. Now, I'll turn it over to Elisha.

[Elisha Finney:]

Thanks, Dow, and hello, everyone. Dow has already covered gross orders, so let me start with backlog. We ended the quarter at $3.5 billion, down 1% from the year-ago period with the gain in Oncology offset by declines in our Particle Therapy and Imaging Components backlog. Backlog adjustments during the quarter totaled $47 million, bringing net orders for the company to $1.1 million. Fourth quarter revenue for the total company were $912 million, up 12% in dollars and up 11% in constant currency. For the year, total company revenues were $3.2 billion up 4$ in dollar and up 5% in constant currency. Oncology posted a fourth quarter revenue gain of 7% in dollars and 6% in constant currency. For the year, Oncology revenues increased 5% in dollars and 6% in constant currency. Imaging Components posted a fourth quarter revenue gain up 7% driven by a recently acquired x-ray accessories businesses, as well as security and inspection products. Including the challenges in the first half, Imaging Components revenue declined 2% for the full year. Our Particle Therapy business posted fourth quarter revenue of $68 million bringing total revenues for the year to $163 million a 13% increase from the prior year. The total company growth margin for the quarter were 42.7% up by nearly four points with significant contributions from both Oncology and Imaging Component. Oncology Systems fourth quarter gross margin improved by about five points to 45.3% with the help of favorable product and geographic mix shift as well as product cost reductions. For the year, Oncology Systems gross margin improved by almost two points to 44.5%. Imaging Components fourth quarter gross margin rose by about three points to 42.1% due largely to favorable product mix, high volumes in Tubes and security product and lower more anti cost. For the year, Imaging Component gross margin improved by about one point to 41.9%. R&D expenses were 66 million, or 7% of revenue, down one point as a percentage of revenue from the year-ago quarter. For the year R&D expenses were 254 million or equal with the prior year as a percentage of revenue at 8%. On a GAAP basis, fourth quarter SG&A expenses were 152 million, or 17% of revenue. On a non-GAAP basis, fourth quarter SG&A expenses were 134 million or 15% of revenue. The 19 million in non-GAAP adjustment primarily related to the plan separation at the Imaging Components business, ongoing pattern litigation and amortization are been tangible. Operating earnings for the quarter were 18.6% of revenue on a GAAP basis and 20.7% of revenue on a non-GAAP basis, reflecting our solid gross margin performance in the quarter. For the year our operating earnings were 17.1% of revenue on a GAAP and up 50 basis points from the prior year to 19.1% of revenue on a non-GAAP basis. Depreciation and amortization totaled 24 million for the fourth quarter and 80 million for the year. The fourth quarter effective tax rate was 31.1%, up from the year-ago quarter due to an unfavorable geographic mix of profits. For the year, the effective tax rate was 27.6%. Fully diluted shares outstanding for the fourth quarter were 94.5 million, down on a 5 million shares from the year ago period due to our ongoing share repurchase program. Fourth quarter diluted EPS was $1.24 for the quarter on a GAAP basis and the $1.38 on a non-GAAP basis. For the diluted EPS was $4.19 on a GAAP basis, on a non-GAAP basis diluted EPS rose 9% to $4.68. Turning to the balance sheet, we ended the quarter with cash and cash equivalents of 844 million, debt of 667 million, and stockholders' equity of 1.7 billion. DSO at 93 days was up from the year-ago quarter, but improved sequentially from the third quarter. Fourth quarter cash flow from operations was 152 million, bringing the total cash flow from operations for the year to 356 million. Primary uses of cash were 87 million for the repurchase of 1 million shares of stock, 43 million to reduce debt, and 20 million for capital expenditures. At the end of the quarter, we had 3.8 million shares remaining under the existing repurchase authorization. Before I turn it over to Dow, as you may have seen in our release issued before this call, I intend to retire from Varian in fiscal 2017. I’ll remain in my current role of CFO until a replacement is found and a fluid transition has been completed. I’ll also continue leading the separation of our Imaging Components business. We have a tremendous financial team that will perform to this transition to a new CFO without missing a beat. It has been an honor to serve all the Varian's Investors and Analyst over the past 17.5 years. And it's been a privilege to be part of a tremendous growth story that has seen Varian become a global power in to fight against cancer. Thank you for being part of the story with me. And now here is Dow.

[Dow Wilson:]

Thanks, Elisha. For our company and for our investors Elisha has been an Intelligent Trusted and Energetic leader that all of its count on to help little winning results. We are just counting it up, we think its 71 quarters. So bravo Elisha with help and guidance, we have achieve the sustain decades long record of growth and revenues and profitability. We have been fortunate to have Elisha on our management team, I’m confident that we will make a smooth transition. Turning now to guidance, we believe that for the first quarter of fiscal year 2017 non-GAAP earnings for the total company including the imaging components business and ramp up costs for a separation will be in the range of $1.3 to $1.7 per diluted share. And revenues will increase by about 1% to 2%. As we announced earlier, we will not give earnings guidance for the full fiscal year until after we have completed the separation of the imaging components business. For the full fiscal year 2017, we expect that Varian’s revenues excluding the imaging components business will rise by 3% to 4%. We expect that imaging components revenues for the full fiscal year 2017 will also rise by 3% to 4%. We are now ready for your questions.

[Operator:]

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions]. Our first question today is coming from Jeff Johnson from Robert W. Baird. Please proceed with your question.

[Jeffrey Johnson:]

Thank you. Good afternoon, guy. Can you hear me okay?

[Dow Wilson:]

Hi Jeff. Loud and clear.

[Elisha Finney:]

Hey Jeff.

[Jeffrey Johnson:]

All right. Great. Elisha I’m not going to touch the 71 quarter comment, I’ll just leave that one alone. I guess, but it’s been great working with you I said that every time, it’s been great working with you for the last seven or eight years that I have covered the stock and I wish you to best in the future.

[Elisha Finney:]

Thank you, Jeff.

[Jeffrey Johnson:]

You are welcome. So two questions here, one I guess just on cash flow. So cash flow was down, I think on a year down about 25% looks like it’s kind of lowest level we have seen since fiscal 2009 and I was going back. And if I add back some of the non-GAAP cash charges even if I add those back still down below $400 million and it looks like receivables were up, I think about $120 million year-on-year and even 50 million up sequentially. So just trying to figure out, it’s a receivable issue, what is going on there or what is going on basically with your cash flow at this point?

[Elisha Finney:]

Sure. So Jeff the oncology AR increased about 8% and that compares the year-to-date sales up 5%. As we have been talking all through this fiscal year early in the year. We moved our collection staff, we had a sales force IT implementation and I think that slowed down collections in the first half and we are continuing to feel that effect all that We are making good progress collections in Q3 and Q4 were very strong. But as we move into FY17 absolutely AR collection is going to be a big focus for the entire team. A little bit of it has to do with more extended terms and a zero interest rate environment, we can continue to win high margin business by offering terms. And then some of it also both inventory and AR up in the Proton business as we continue to grow that business. And with percentage of completion accounting, it gets a little funky in Proton, because a lot of times were taking revenue and creating an AR under the percentage of completion long before the bills are actually due by the customer. But it will be a big focus as we move into this year.

[Jeffrey Johnson:]

Okay, and I know you don’t guide the cash flow I mean on a consolidated basis, can we expect to get back above $400 million in a year we almost touching $500 million a couple of years ago and it seems like $350 million can we at least get back above $400 million, do you think over the next year too?

[Elisha Finney:]

That is absolutely my goal this year, and also contracted [indiscernible] were down in the Proton business with orders being lower that drove about I think $40 million or bit so. But yes, our goal is what we did back on a consolidated basis to you know the $400 million level.

[Jeffrey Johnson:]

Yes, all right and Dow from a guidance stand point. You know I think we all knew you work on a issue full year guidance from an EPS perspective and we understand the reasons why, but if I look at, if I look at first quarter guidance from an EPS perspective. You are guidance about 5% to 6% EPS growth on a year-over-year basis. Is it fair to think about that on kind of a core basis over the following few quarters, obviously we have to take into account that extra $20 million of revenue dyssynergies that will start to hit those to back three quarters. But outside of that issue, is kind your first quarter guidance a reasonable wait of think about kind of the core outlook for the rest of the year?

[Dow Wilson:]

Let me talk to the market slight a bit and then I will let Elisha talk it to nothing goes on the guidance side. I think from market perspective, we had big comp in Europe here in the fourth quarter but fundamentally we had a very sound year in the U.S. we see that continuing next year. our funnel remains very good in the U.S. in Asia, China was a little bit off due to some of the structural issues we have seen there, but we think that that market remains robust and should kind of bounced back to double digit levels. And then the question for us all this year has been kind of Western Europe and where is it going to land. You know we have talked about on that on this call about it being soft all this year. As we close the year, I would say we feel pretty good about Europe for next year. So, just kind of rounding out the market and top-line side of it I think we feel pretty good about where the market is going to be globally next year with especially Western Europe bouncing back.

[Elisha Finney:]

Yes, so for specifically re for Q1 of FY 2017 Jeff, that 1% to 2% on the revenue side, Varian Oncology and Proton is going to be flattish on revenue, but that's really because in the year-ago Q1, we had something like 9% constant currency revenue growth and then we looked at Q2 it was actually a percent. So this is just a matter of timing and I think to revenue will be split more evenly between one and Q1 and Q2. So again 3% to 4% for the full year for Oncology. Q1 for Varex the Imaging Component business should be up in the current low double digit range and that versus a very easy year-ago comp as their recovery continues. On EPS if you look at our range, it would be 4% to 8% EPS growth versus a year-ago quarter. but I need to stress that also includes $0.01 to $0.02 cost that we are building in the Imaging Components business today to prepare them for the stand. So for an example, they have hired to CIO, they have hired a manager of tax. As their building out their corporate function, those costs are duplicated in this quarter and so really you need to tack on an additional $0.01 to $0.02 to account for that to get to an apple-to-apple.

[Jeffrey Johnson:]

Okay and I guess I’ll just repeat the last part of my question which was, is it fair to think of that 4% to 8% EPS growth is kind of a core range we could think of for the rest of year before we then tack on that 20 million of the dyssynergies?

[Elisha Finney:]

Okay so let me answer it this way, and this is a completely non-relevant a number, but I’ll give it to you anyway, because we are going forward with this stand, but if we weren’t spending I believe fiscal year 2017 on a consolidated basis we could grow EPS in the high-single-digit range.

[Jeffrey Johnson:]

Okay, all right that’s a good start. I appreciate it. Thanks Elisha.

[Operator:]

Our next question today is coming from Amit Hazan from Citi. Please proceed with your question.

[Amit Hazan:]

Good afternoon guys and let me just add, Elisha had been a great run and we will definitely miss you.

[Elisha Finney:]

Thank you Amit.

[Amit Hazan:]

Let me start with the guidance on the top-line that you guys talked about the 3% to 4% top-line growth. I just want to make sure we understand that the reported number and constant currency number first and then either way really is that kind of look at orders for Oncology and obviously now pretty much for last couple of years on a reported basis backlog kind of flattish. So maybe just help us Elisha kind of get to that 3% to 4% growth range versus the order in the backlog growth rate we have been seeing?

[Elisha Finney:]

Yes, well that’s assuming at today's exchange rate which fortunately have stabilized over the last several quarters. The euro has stabilized, the yen is obviously helping us, if yen weakened significantly that could be an impact, but look at where currency rates are today that 3% to 4% for Oncology and Proton combined, feels about right, that does compare to an Oncology backlog that’s up 3% at the end of the fiscal year 2016. So that looks pretty achievable going into FY2017.

[Amit Hazan:]

Okay. And let me just follow-up on the order side on Europe. I mean if I look at EMEA for the year down 4%, I think there is obviously some tough comps there, but are you actually seeing some issues that have been persistent in Europe that you would call out that you don’t have great visibility to them ending other easy comps or. Maybe just a little bit more color on what is going in the issues that have seeing have been or continue to be persist, and what those are?

[Dow Wilson:]

Sure, through the course of 2016, I mean I think we had weakness especially in UK, France and Germany and as I mentioned in my response to Jeff's question, we are seeing our funnels in those markets and the rest of Western Europe and the rest of our European map look pretty good as we look forward. So I think we are little more encourages about what we see forward than what we see backwards. So we also see some opportunity in Italy and Spain going forward. And then of course our map of Europe includes Africa, Middle East, India and those markets were good to us in Q4 and we see those as continue to strength from those markets.

[Amit Hazan:]

And then last one from me just on the [indiscernible], maybe just give us a sense of when those units would actually be booked as orders, if haven't be booked already? And then you kind of talk about that is Phase I, to the extent if you can maybe just talk about they are obviously a big organization right on center perspective. Just the installed base, how much of it is yours and the expense kind of potentially for maybe I would two year how you see that develop beyond these first 14 units or so?

[Dow Wilson:]

Yes. Although, we book so far is this first 14 units. So that’s just this first phase, we feel very good about our relationship with McKesson U.S. Oncology Vantage. What we have booked so far is pretty much the hardware piece of the relationship. The contract does include software and service and that will be booked, some of it next year and beyond. So we feel very good about where that is headed, I think they are very much and think for what the software product have to do in terms of managing the clinic, providing the analytic tools, macro reimbursement tools, it will include some interoperability with the McKesson iKnowMed product, which was important for McKesson. And very excited about that whole relationship, but most of it is yet to be booked.

[Amit Hazan:]

All right. Great. I’ll let some others jump in. thanks guys.

[Operator:]

Thank you. Our next question today is coming from Tycho Peterson from JP Morgan. Please proceed with your question.

[Tycho Peterson:]

Thanks. I apologies I’m going to ask another guidance question. But if you think about kind of the end markets values to talk about kind of 6% to 8% market growth then it was kind of mid-single-digits. You are talking 34% revenue growth with some share gains I guess embedded into. Can you maybe just talk about what you see as underlying market growth and in 3% to 4% revenue guidance, how much of that is software and services versus underlying growth in LinAcc?

[Dow Wilson:]

I don’t know if I can break that out at this point from a guidance point of view. But as to the overall markets, I mean if anything you might have been a little bit conservative here. I think as we look our funnels here at the beginning of the year, I think the market looks pretty good. We had a ton of activity in especially in the fourth quarter in Europe last year and as we look forward, we see pretty good strength. So I would say there are uncertainty around the course, but it’s probably 3% to 3.5% to 6% market growth scenario. Chin is going to continue to do well. India is going to do well, We are growing in Africa. We had pretty good years this past year in Brazil, but we see continued strength in the Brazilian market and that’s good news. And then in the U.S. market it’s been as I mentioned in the scripts, it was 5% growth on the year and if anything that would a little bit ahead it kind of where we thought, it would be coming into the year as we look at 2017 funnels remain very strong in the U.S.

[Elisha Finney:]

If I could just add to that Tycho, in terms of the top-line growth for oncology, the good news is pricing is holding globally and we have seen significant product cost reduction, we have basically obsoleted the C Series and moved everyone on to the TrueBeam platform. And I think this margin improvement, you have seen the last couple of quarters and oncology is sustainable going forward. So We are kind of moving them up to 44% to 45% gross margin level and so obviously even at the top-line is off a point or so, we make up a lot of that difference in the margin improvement that we are seeing there.

[Tycho Peterson:]

Okay. That's good to hear, and then Dow may be could you help on macro the final rule where your thoughts on. As we think about that getting implemented how do we think about that may be driving more of a bias towards software and some of this.

[Dow Wilson:]

Yes, no I think we are overall it's a good opportunity for our product line with our insight of analytics tools, our rapid plan and treatment planning and our 360 Oncology you know its connect trade and opportunity. For us to provide our customers with required reports they're going to need to comply. They have got a demonstrate certified the HER, Electronic Health Record. They have got to demonstrate improvement in care management and practices and they have a report on their quality metrics. So these tools all do that. So I think it’s going to be pretty good news for us. The product line is about where we needed to be to comply we got few things to button down but we will be way ahead of the in the compliance requirements and we have got just our own installed base is about 18,000 sites that got to go and we are very excited about that. May be just on top of that this is a macro but the other keys from a market point of view that is a least as important as macro is the cyber security. And you know this at ASTRO we launched a very significant upgrade to our software products for cyber security and that product could be ready here in early spring and that should drive some upside for us too, so we are excited about that one.

[Tycho Peterson:]

And then one last one, you know North America Oncology orders last quarter up 15%, they were up only 3% this quarter, were there some pull forward dynamic to CMS to kind of come out ahead time and said physician fee schedule wouldn't be [indiscernible]?

[Dow Wilson:]

You know there is always from lumpiness quarter-to-quarter, I would say, in the second half the CMS had very little to do with this. You know it's just timing of some of the orders.

[Tycho Peterson:]

Okay. Thanks.

[Operator:]

Thank you. And our next question today come from Vijay Kumar from Evercore ISI. Please proceed with your question.

[Dow Wilson:]

Hi Vijay.

[Vijay Kumar:]

Hey guys, how it's going?

[Elisha Finney:]

All right.

[Vijay Kumar:]

So, Elisha maybe I'll start one with the a question for you just sort of fund of timing here, just on the decision to step aside, if you could just walk us through some the claiming mission I think that will be helpful context in the heading into the span?

[Elisha Finney:]

Sure, well I started my CFO career with the span, I figured why not end it with a span. So, back in 1999 and as Dow said about 71 quarters , it just feels like to right timing Vijay. In terms of the exact timing that's to be determined, I am completely dedicated to getting us through to span of the Imaging Components business. We can now go out and conduct a research and want to find a world class finance leader who can come into describe organization and have time to transition and so it will be at some point in this fiscal year but the exact date is are not determined at this point.

[Vijay Kumar:]

Got you, and may be just a couple of a quick one on the guidance question. So did I hear you correctly when you said the EPS was a high single off of the current year base and just does that number include the 20 million dyssynergies and you have the accounting rule change sort of baked in and just can you walk us through some moving parts there?

[Elisha Finney:]

Yes, that was a hypothetical number that said if we weren’t spending, we believe EPS would grow on a consolidated basis in the high-single-digits. The 20 million of dyssynergies, I have to say we are well underway of looking for cost reduction opportunities and we are absolutely committed to having $10 million of that out at a run rate by the end of fiscal year 2017 and the additional $10 million out by FY 2018. So lots of work already going on that. I will tell you that most of those dyssynergies for Varian are offset because we will have a lower tax rate, because Varex has a 35%, 36% tax rate. Unfortunately for my colleague [Clarence Verhoef] (Ph) his tax rate is going up versus the Varian average but a Varian’s tax rate will come down a point or two and that largely offset the dyssynergies in you are wanting to.

[Vijay Kumar:]

That was helpful. And maybe just a quick one on Q1. I mean if I look at the guidance commentary at the midpoint EPS, it looks like maybe margins would be somewhere around 17.5 maybe a few basis point above the 17.5. so that’s a step down just from the Q4 levels, commentary on which is gross margin for Oncology, can you just walk us through why the margins were step down from Q4 to Q1? Thank you.

[Elisha Finney:]

Yes, you always. Every year if you go back you see seasonality, I mean Q4 is always our largest quarter with the highest operating margin typically. So it's not uncommon for the operating margin to step down from Q4 to Q1. When you run your model through, I mean what I am showing at the mid-point is that we will increase our operating margin by about a point to 18% on a non-GAAP basis. Again, Oncology’s gross margin will be between 44%, 45%, Imaging Components in the low 40s. So it's looks closer to an 18% operating margin.

[Vijay Kumar:]

Thank you guys.

[Elisha Finney:]

And again Vijay, that does include - I want to make sure everyone understands, it includes some duplicative cost and Varex as we are hiring people to gear up with the span, we cannot take those cost out to be non-GAAP and that’s between $0.01 and $0.02 in Q1 for those duplicative cost.

[Vijay Kumar:]

Very helpful. Thank you.

[Operator:]

Thanks. Our next question today is coming from Anthony Petrone from Jefferies. Please proceed with your question.

[Anthony Petrone:]

Thanks and congratulation Elisha, it was great working together over the years and good luck on the next phase.

[Elisha Finney:]

Thank you.

[Anthony Petrone:]

A couple of questions just I guess higher level, maybe exiting fiscal 2016 here will be helpful to get an update on the percentage of the installed base, the LinAcc installed base that really is now TrueBeam and VitalBeam. And really what I am getting out is what percentage of the installed base has stereotactic to capabilities and what percent is not truly in relation to Dr. Kuntia’s presentation at ASTRO. The opportunities for SRS, SBRT going forward over the next 10 to 15 year. I am just trying to get a sense of what percentage of the base can migrate to having stereotactic capabilities in the next few years? And then I have a follow-up on software and margins.

[Dow Wilson:]

That’s a good question, I would say from a very high level we have got about 1,500 TrueBeams in the installed base of call it 7,500 machines. Now, when you look at some of the capabilities, the interesting thing, when you talk about HyperArc. HyperArc available on every one of those TrueBeams. So this is kind of first, we have had some other smaller upgrade that we offered on TrueBeam like some imaging improvements and some other things over the last few years. But the HyperArc for some of the stereotactic radiosurgery patients that Dr. Kuntia talked about at ASTRO will be available on the Edge and TrueBeam only. So very excited about that. I think that will probably drive some of the other installed based to trade out to TrueBeam as well. So very encouraged about that, I would say when you look at the past quarter Americas was almost virtually 100% TrueBeam, VitalBeam might have been one or two that weren’t, but pretty much everything in the Americas, that well North America for sure was TrueBeam, VitalBeam. And I would say of those in terms of the capability that they had in the fourth quarter. Maybe half had SRS, SBRT capability. When you look at the install base big opportunity there. Most of them do not have that capability. And so I think, this bodes well for us next year in two ways, one it’s an upgrade opportunity and two it’s going to help us on pricing on TrueBeam. We are going to be able to maintain or grow price on TrueBeam and I think that’s a little bit, We are doing very well on the cost side. Where is this margin rate improvement coming from are doing very well on the cost side the operational team has done a fabulous job getting cost down on TrueBeam. But then as well We are seeing a really nice mix of these advanced capabilities that are giving us some price support on the pricing side.

[Anthony Petrone:]

And just a quick follow-up on that, that would be just. How do you see that transitioning, just when you think of the 2019 reimbursement changes when oncology may go bundled and then more focused on efficiencies and outcomes? Does it accelerate the demand for stereotactic within the installed base or do you think this sort of plays out pretty ratably over 12 to 15 years?

[Dow Wilson:]

I mean, I think, if anything that will be a little faster, because some of the reimbursement pressure. Having said that, clinicians are going to want to make sure there is a really responsible clinical comparison done. So our customers are sensitive about that. I think one of the exciting things to us is in some applications the hypofractionation trend is going to bring more patients back to us. So for example, in prostate cancer over the last half dozen years, we have lost a little bit of share at robotic surgery. But I think now as those starts to go hypofractionated we get those, a lot of those patients back. Results are as good or better than surgery and that’s well documented. And then as well, I think the other big opportunity from a clinical growth perspective here is metastatic disease, this capability really enables a very precise dose deposition. And we think that there are in the U.S. alone 300,000 patients that we get could have opportunity to go after with this capability and bring some new folks into the radiation therapy paradigm. So we are excited about the capabilities this opens up.

[Anthony Petrone:]

And then just quickly on software margins may be just another high level. Where do we sit exiting fiscal 2016 when you look at software/services as a percent of the total for the [remain co] (Ph) and do you see a point where there is a higher mix of software. Say over the next three to five years and if we do have that scenario what do you think overall margins look like under that scenario? Thanks again.

[Elisha Finney:]

Let me just say for you to date 2016 service was just low 40. There was about 42% of the total revenue for Oncology so call it 60/40. And clearly as of service and software grow faster than the hardware. It does have an upward bias on gross margin. In fact that has been helping us for last couple of quarters. Software is roughly 10% of total Oncology revenue.

[Anthony Petrone:]

Thanks.

[Operator:]

Thank you. And our next question today is coming from Brandon Henry with RBC Capital Markets. Please proceed with your question.

[Brandon Henry:]

Hey, thanks for taking my question. First of all can you just discuss how software and services performed in the quarter. These businesses continue growing combined kind of high-single-digits. And were there any change in growth rate this quarter versus last quarter?

[Dow Wilson:]

Our revenue in service were up 7%, revenues in software were around the same. I think the as we look forward in the service funnel I would say it looks very good. We had a little bit of currency last year, we had a little bit of timing. I think on the year we would like to see that number be a little of north of 7% and that's kind of what we are stressing the team for, but service business continues to be solid growth for us. Software, we had the very good year in treatment planning. We talked about that in the script with all the rapid plan orders. I think this next year with the improvements that we have in our in insight of analytics and with our 360 Oncology product. It can be very exciting. We are curious little bit to see how that goes because 360 Oncology is going to be cloud based. So the financial impact is going to be a little more back end loaded as we accumulate sites, do to billing and collect the orders on that basis. I think it's going to be a little - it is a little bit of a transition as we go kind of from annual license model to a software-as-a-service model. So having said that, one of the really cool things about the 360 Oncology product is it can play not just in ARIA Varian side, it can play in every radiation Oncology site in the world and just a really a great opportunity for us to get some penetration, in fact we that we don’t have today.

[Brandon Henry:]

Okay and then separately can you guys talk about your expectation for free cash flow for fiscal year 2017 versus fiscal year 2016 and how should we think about the balance of M&A versus share repurchase is in the near-term and then what size deals and debt levels do you feel comfortable for each company going forward? Thanks.

[Elisha Finney:]

I'll answer the first part of that to have question Brandon, as it has came up earlier on the call. Our cash flow from operations was down year-over-year we ended both Q3 and Q4 on a strong note, but we were kind of in a whole in that. The first half of the fiscal year on collections of AR for a couple of reasons moved this collection staff, we had at IT implementation et cetera. So we are very focused on cash flow particularly AR as we move into FY 2017 and on a consolidated basis our expectation would be that we could get back to around the $400 million level in cash flow from operations. CapEx has always been relatively stable. And then in terms of share repurchase versus M&A, I think we would always love to prioritize M&A if the right targets come along in that’s the duty of our share repurchase program we can turn it on and off and at various levels depending on what activity in M&A that’s there.

[Dow Wilson:]

Yes, and just as a comment, it's can be strategically driven, how can we strengthen our Oncology franchise, I don’t see us going way out on the edge and doing something for example maybe in chemotherapy to pick one. But other image guidance technologies, are there radiation technologies, are there software technology that can reinforce our core and give us some higher growth segments to participate in. That’s what we will look at.

[Brandon Henry:]

Okay. Thank you.

[Operator:]

Thanks. Our next question is coming from Anthony Petrone from Jefferies. Please proceed with your question.

[Anthony Petrone:]

Just a quick housekeeping one, just kind of going to some queues here on the Kendall acquisition in Poland, maybe what is baked in there for fiscal 2017 and if any of that hit in the fiscal fourth quarter as well? Thanks again.

[Elisha Finney:]

In terms of revenue?

[Anthony Petrone:]

Yes, revenue contribution in the quarter and then…

[Elisha Finney:]

It would just be service revenue about $1 million or so this fall.

[Anthony Petrone:]

In Q4 and I guess if we just annualize that in 2017 to get the contribution or…

[Elisha Finney:]

Yes. It's somewhere between annualized $14 million to $16 million market for us and it's a growing market, so we feel very good about Poland over the next several years. And one of the reason is the timing was right to make the acquisition and go direct.

[Anthony Petrone:]

Okay. Thank you again.

[Operator:]

Thank you. We have reached end of our question-and-answer session. I would like to turn the floor back over to management for any further or closing comments.

[Dow Wilson:]

Thank you. Thank you all for participating. A replay of the call can be heard on the Varian’s 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 201-612-7415 from outside the U.S., and entering confirmation code 13647671. The telephone replay will be available through 5

[Operator:]

Thank you. That does conclude today's teleconference. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.