VARIAN MEDICAL SYSTEMS, INC. Forward-Looking Statements This Quarterly Report on Form 10-Q contains "forward-looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995, which provides a "safe harbor" for statements about future events, products and future financial performance that are based on the beliefs of, estimates made by, and information currently available to the management of the Company. The outcome of the events described in these forward-looking statements is subject to risks and uncertainties. Actual results and the outcome or timing of certain events may differ significantly from those projected in these forward-looking statements or management's current expectations due to the factors cited in this "Management's Discussion and Analysis of Financial Condition and Results of Operations," the Risk Factors listed under Part II, Item 1A of this Quarterly Report on Form 10-Q, and other factors described from time to time in our other filings with theSEC , or other reasons. For this purpose, statements concerning: the continuing impact of the COVID-19 pandemic on our business, including but not limited to, the impact on our workforce, operations, supply chain, demand for our products and services, and our financial results and condition; our ability to successfully manage the challenges associated with the COVID-19 pandemic; our ability to achieve expected synergies from acquisitions; risks associated with integrating recent acquisitions; global economic conditions and changes to trends for cancer treatment regionally; currency exchange rates and tax rates; the impact of the Tax Cuts and Jobs Act; the impact of theAffordable Health Care for America Act (including excise taxes on medical devices) and any further healthcare reforms (including changes to Medicare and Medicaid), and/or changes in third-party reimbursement levels; tariffs and exclusions therefrom, cross-border trade restrictions; demand for and delays in delivery of the company's products; the company's ability to develop, commercialize and deploy new products; the company's ability to meetFood and Drug Administration (FDA) and other regulatory requirements, regulations or procedures; changes in regulatory environments; risks associated with the company providing financing for the construction and start-up operations of particle therapy centers, challenges associated with commercializing the company's Proton Solutions business; challenges to public tender awards and the loss of such awards or other orders; the effect of adverse publicity; the company's reliance on sole or limited-source suppliers; the company's ability to maintain or increase margins; the impact of competitive products and pricing; the potential loss of key distributors or key personnel; challenges related to entering into new business lines; the expected timing of the closing of Merger, the estimated amount of advisory fees related to the Merger; the occurrence of any event, change or other circumstances that could give rise to the termination of the Merger Agreement; the failure to obtain certain required regulatory approvals or the failure to satisfy any of the other closing conditions to the completion of the Merger; risks related to disruption of management's attention from the Company's ongoing business operations due to the Merger; the effect of the announcement of the Merger on the ability of the Company to retain and hire key personnel and maintain relationships with its customers, suppliers, distributors and others with whom it does business, or on its operating results and business generally; the ability to meet expectations regarding the timing and completion of the Merger; risks associated with Merger-related litigation; and any statements using the terms "believe," "expect," "anticipate," "can," "should," "would," "could," "estimate," "may," "intended," "potential," and "possible" or similar statements are forward-looking statements that involve risks and uncertainties that could cause our actual results and the outcome and timing of certain events to differ materially from those projected or management's current expectations. By making forward-looking statements, we have not assumed any obligation to, and you should not expect us to, update or revise those statements because of new information, future events or otherwise. This discussion and analysis of our financial condition and results of operations is based upon and should be read in conjunction with the Condensed Consolidated Financial Statements and the Notes included elsewhere in this Quarterly Report on Form 10-Q and the Consolidated Financial Statements, the Notes to the Consolidated Financial Statements and the related Management's Discussion and Analysis of Financial Condition and Results of Operations in the 2020 Annual Report, as well as the information contained under Part I, Item 1A "Risk Factors" of the 2020 Annual Report and Part II, Item 1A "Risk Factors" of this Quarterly Report on Form 10-Q, and other information provided from time to time in our other filings with theSEC . Overview We,Varian Medical Systems, Inc. , are aDelaware corporation originally incorporated in 1948 asVarian Associates, Inc. We are the world's leading manufacturer of medical devices and software for treating cancer and other medical conditions with radiotherapy, stereotactic radiosurgery, stereotactic body radiotherapy, brachytherapy and proton therapy. We operate a hospital and a network of cancer centers inIndia andSri Lanka ; provide cancer care professional services to healthcare providers worldwide; and are a supplier of a broad portfolio of interventional solutions. Our vision is a world without fear of cancer. Our mission is to combine the ingenuity of people with the power of data and technology to achieve new victories against cancer. Our long-term growth and value creation strategy is to transform our company from the global leader in radiation therapy (also referred to as radiotherapy) to the global leader in multi-disciplinary, 33 -------------------------------------------------------------------------------- integrated cancer care solutions that leverages our clinical experience and strengths in technology development and new product innovation. To achieve these long-term objectives, we are focused on driving growth through strengthening our leadership in radiation therapy, extending our global footprint and expanding into new markets and therapies. We have two reportable operating segments: Oncology Systems and Proton Solutions. Our Interventional Solutions business is reflected in the Other category because it does not meet the criteria for a reportable operating segment. The operating segments were determined based on how our Chief Executive Officer, who is our Chief Operating Decision Maker ("CODM"), views and evaluates our operations. The CODM allocates resources to and evaluates the financial performance of each operating segment primarily based on operating earnings. We report revenues in three regions. TheAmericas region includesNorth America (primarilyUnited States andCanada ) andLatin America . The EMEA region includesEurope ,Russia , theMiddle East ,India andAfrica . The APAC region primarily includes East andSoutheast Asia andAustralia . Proposed Acquisition by Siemens Healthineers OnAugust 2, 2020 , VMS, Siemens Healthineers, Merger Sub, and, with respect to certain provisions, the Guarantor, entered into the Merger Agreement, pursuant to which, on the terms and subject to the conditions set forth therein, Merger Sub will be merged with and into VMS, with VMS surviving the Merger as a wholly owned subsidiary of Siemens Healthineers. Under the terms of the Merger Agreement, which has been unanimously approved by VMS' Board of Directors, Siemens Healthineers will acquire all outstanding shares of VMS for$177.50 per share in cash, in a transaction valued at approximately$16.4 billion on a fully diluted basis. The Merger is expected to close in the first half of calendar year 2021, subject to receipt of specified regulatory approvals and other customary closing conditions. OnOctober 15, 2020 , VMS' stockholders approved and adopted the Merger Agreement. Under the terms of the Merger Agreement, if the Merger Agreement is terminated by VMS or Siemens Healthineers under certain specified circumstances, a termination fee of$450.0 million in cash may be payable by VMS to Siemens Healthineers. The Merger Agreement also provides that a reverse termination fee of$450.0 million or$925.0 million in cash may be payable by Siemens Healthineers to VMS if the Merger Agreement is terminated by VMS or Siemens Healthineers under certain specified circumstances. COVID-19 Impact The COVID-19 pandemic has impacted our day-to-day operations and the operations of the vast majority of our customers, suppliers and distributors globally. The COVID-19 response by hospitals and healthcare professionals has placed a severe strain on healthcare systems. Many of our hospital customers have prioritized their efforts on their COVID-19 response and have diverted focus and resources away from their normal operations and restricted access to their sites in efforts to contain the spread of the virus. The global nature of the pandemic has resulted in authorities implementing numerous measures designed to contain the virus, including travel bans and restrictions, border closures, quarantines, shelter-in-place orders, business limitations and shutdowns. The prioritization of COVID-19 treatment and containment have presented us with unique operational challenges, including delays in capital equipment purchasing decisions by customers, obstacles to our ability to market, deliver, install and service our products, and disruptions and delays in our logistics and supply chain. Revenues and Orders Trends The impact of COVID-19 on our operations has varied by region, with mixed impacts based on the geographical spread, stage of containment, and recurrence of the pandemic in each region. Our operations inChina were impacted first, beginning early in the second quarter of our fiscal year 2020, followed by other parts of ourAsia Pacific geography, with our EMEA andAmericas geographies experiencing the initial impacts of the pandemic late in the second quarter of our fiscal year 2020. Our second quarter revenues were trending higher than the comparable second quarter fiscal 2019 period, untilMarch 2020 when we started to experience a decline in hardware product revenues in our EMEA andAmericas geographies due to the spread of COVID-19. In the third quarter of our fiscal year 2020, these trends in declining revenues continued across all of our geographies, both in comparison to the second quarter of our fiscal year 2020 and in comparison to our third quarter of fiscal 2019, with the exception of revenues from theChina region, which increased with respect to both comparison periods, driven by recovery from COVID-19 inChina which began at the end of the second quarter of our fiscal year 2020. In the fourth quarter of our fiscal year 2020, we experienced improvement in revenues in comparison to the third quarter of our fiscal year 2020 in all three geographies, although our total revenues decreased by 3% in comparison to the fourth quarter of our fiscal year 2019. The sequential improvement in revenues was driven primarily by fourth quarter seasonality and to some extent by recovery in ourAmericas and EMEA geographies and continued recovery inChina and otherAsia Pacific countries. We continued to experience sequential recovery globally in the first quarter of our fiscal year 2021, although total revenues decreased 6% in comparison to the first quarter of our 2020 fiscal year, at which point we had not begun to experience impacts from the COVID-19 pandemic, and decreased 8% in comparison to the fourth quarter of our fiscal year 2020 due to fourth quarter seasonality. 34 -------------------------------------------------------------------------------- We have experienced adverse impacts to revenues for both our hardware and software products, primarily resulting from customer capital constraints, site access challenges and delays to pre-installation activities. We have experienced minimal impact to our services revenues and expect that our services revenues will continue to be reasonably insulated from COVID-19 given the long-term nature of the underlying contracts and our current installed base; however, installation and commissioning service revenues linked to hardware installation have trended downward, consistent with delays to hardware installations. If treatment volumes decline materially and impact hospitals' operating costs, it may impact our service contract renewals, pricing and service revenues. We have experienced similar trends in orders as we have in revenues. We began to experience delays in orders, primarily for capital equipment, during the second quarter of our fiscal year 2020. Orders continued to decline across most regions during the third quarter of our fiscal year 2020, with our EMEA geography experiencing the most severe negative impact to orders and ourAmericas geography also experiencing significant negative impacts. However, in the third quarter of our fiscal year 2020 our APAC geography experienced an increase in orders both in comparison to the second quarter of our fiscal year 2020, driven by recovery inChina , and in comparison to the third quarter of our fiscal year 2019, driven by recovery inSoutheast Asia andKorea . In the fourth quarter of our fiscal year 2020, we experienced significant improvement in orders compared to the third quarter of our fiscal year 2020 in all three geographies, as our customers began to resume capital purchasing activity, although our total gross orders decreased by 8% in comparison to the fourth quarter of our fiscal year 2019. We continued to experience improvement in orders globally in the first quarter of our fiscal year 2021. Total gross orders increased by 4% in comparison to the first quarter of our fiscal year 2020, although total orders did not increase sequentially quarter- over- quarter due to fourth quarter seasonality. We are not able to accurately predict the full impact that COVID-19 will have on our future results of operations, financial condition, liquidity and cash flows due to numerous uncertainties, including the duration and severity of the pandemic and the extent and effectiveness of containment measures imposed in different geographies, including vaccination programs. To the extent lockdown measures continue to restrict access to customer sites and delay vault construction or such measures increase in scope and duration, it could have an adverse impact on our revenues during our fiscal year 2021. In addition, a lack of coordinated COVID-19 response by theU.S. government, including with respect to vaccination programs and variants in the virus, could result in significant increases to the duration and severity of the pandemic inthe United States . We expect that customer financial constraints, foreign currency headwinds, and uncertainty around the pandemic may lead our customers to continue to defer capital equipment purchases during our fiscal year 2021. We believe that we will continue to experience improvement in both our revenues and orders over the course of our fiscal year 2021 to the extent COVID-19 impacts to our operations continue to decrease as the pandemic is controlled. We believe that our existing orders backlog, together with recurring services revenues, should soften the impact of order delays on our revenues. Based on regional machine utilization trends, beginning in the fourth quarter of our fiscal year 2020, radiation therapy treatment volume levels have been returning to historical averages in certain regions that experienced recovery from the pandemic, which we would expect to have a corresponding positive impact on hospital operating budgets; however, lockdown measures that were put in place in response to resurgence of the pandemic in several countries could negatively impact utilization trends. We expect to continue to experience some logistical, manufacturing and shipment delays, and some increased logistics-related costs for so long as COVID-19 related travel and customer site access restrictions remain in place. General Increase in Risks While we believe that orders trends and our revenues will return to historical norms over time as the pandemic is controlled, if the COVID-19 pandemic proliferates for an extended period, capital expenditure delays could be prolonged and have a material impact on revenues and orders well into our fiscal year 2021. Worldwide economies have been significantly impacted by the COVID-19 pandemic, and onJune 8, 2020 , theNational Bureau of Economic Research announced thatthe United States was in recession. An extended economic recession inthe United States or elsewhere could have a material adverse effect on our business over the longer term if hospitals reduce or curtail capital and overall spending. Some of our hospital customers may decide to no longer purchase our products or services, and certain of our customers, suppliers and distributors may become insolvent.
For additional information on risk factors that could impact our results, please refer to "Risk Factors" in Part I, Item 1A of this Form 10-K.
Our Response
Since the outbreak of the pandemic, our focus has been on keeping our employees
safe, supporting our customers and their patients, and ensuring supply chain
stability and business continuity.
35
--------------------------------------------------------------------------------•Our employees are crucial to our mission, and we have taken the following actions to ensure their safety and well-being.
•We have instituted work-from-home policies and workplace safety measures and protocols, including strict site access guidelines and ensuring the availability of personal protective equipment. To support the health and well-being of our employees, customers, distributors, partners and communities, as ofOctober 2, 2020 , approximately 54% of our employees are working remotely, whereas typically only 15% of our employees, such as field service employees, work remotely.
•We have implemented new programs aimed at educating our employees on how to operate in virtual, social-distancing environments.
•As of
•Our customers are facing unique challenges, and we are taking actions to support their priorities. Among other efforts, we are taking actions to ensure that all of our customers can continue to deliver radiation therapy, a non-elective procedure, to their patients, and we are actively deploying remote tools across our training, installation and field service teams to ensure continued access to our products and solutions. •Despite certain logistical and manufacturing challenges, to date, we have been successful in our efforts to secure and stabilize our global supply chain, and we are actively coordinating with our suppliers and distributors to maintain adequate inventory to fulfill our customer commitments. •We have a solid balance sheet, as ofJanuary 1, 2021 , with approximately$1.7 billion in accessible liquidity, including approximately$773 million in cash and cash equivalents and approximately$972 million available under our$1.2 billion revolving credit facility. To date, we have not experienced a significant decline in customer credit quality or a significant increase in requests for changes or extension of payment terms as a result of COVID-19, although we will continue to closely monitor these metrics going forward. While our capital allocation priorities remain unchanged, as a precautionary measure we have paused our share buybacks to preserve liquidity and are focused on reducing costs to bolster our financial flexibility in light of the broad range of potential outcomes over the foreseeable future. In our third and fourth quarter of fiscal year 2020, we implemented several cost cutting measures designed to preserve liquidity, including a reduction in force that impacted approximately 3% of our work force, a temporary reduction in certain employee benefits, and requiring our employees to take mandatory paid personal leave days during a set week in each of the third quarter and fourth quarters of our fiscal year 2020 and in the first quarter of our fiscal year 2021. Despite the challenges that we are facing due to the COVID-19 pandemic, we remain confident that the actions that we are taking to manage such challenges, combined with our strong liquidity, position us well to navigate through the current economic environment and continue to execute on our long-term value creation strategy. 36 -------------------------------------------------------------------------------- Highlights for the Three Months EndedJanuary 1, 2021 Financial Summary Three Months Ended January 1, January 3, (In millions, except per share amounts) 2021 2020 Change Gross Orders$ 853.7 $ 818.6 4 % Oncology Systems 789.4 773.8 2 % Proton Solutions 55.6 25.9 114 % Other 8.7 18.9 (54) % Backlog$ 3,381.7 $ 3,305.3 2 % Revenues$ 778.8 $ 828.9 (6) % Oncology Systems 744.5 782.4 (5) % Proton Solutions 25.6 27.6 (7) % Other 8.7 18.9 (54) %
Gross margin as a percentage of revenues 46.1 % 44.2 % 190 bps
Effective tax rate 22.2 % 21.0 %
Net earnings attributable to Varian $ 96.5 $ 88.2 9 %
Diluted net earnings per share $ 1.05 $ 0.96 9 %
Net cash provided by operating activities
26 %
Number of shares repurchased - 0.3 n/m
Total cost of shares repurchased $ - $ 46.4 n/m n/m - not meaningful Tariff Measures. BetweenJuly 2018 andMay 2019 , theTrump Administration imposed a series of tariffs, ranging from 5% to 25%, on numerous products imported intothe United States fromChina , including Varian's radiotherapy systems manufactured inChina and certain components used in our manufacturing and service activities. In July andAugust 2018 ,China retaliated against theU.S. tariffs by imposing its own series of tariffs, ranging from 10% to 25%, on certain products imported intoChina fromthe United States , including Varian's radiotherapy systems and certain manufacturing and service components. We participated in theOffice of the U.S. Trade Representative ("USTR") process to seek product-specific exclusions from theU.S. tariffs on Chinese imports. To date, USTR has granted tariff exclusions for four products: certain radiotherapy systems manufactured inChina , as well as three key components of the radiation therapy systems that we manufacture inthe United States : multi-leaf collimators, certain printed circuit board assemblies and tungsten shielding. We submitted an additionalU.S. exclusion request inSeptember 2019 , in relation to a manufacturing component, which was ultimately not granted. In 2019, USTR granted a one-year extension to our exclusion for radiotherapy systems throughDecember 28, 2020 , which has now expired. Two additional component exclusion extensions, for multi-leaf collimators and certain printed circuit board assemblies, were granted throughDecember 31, 2020 and only multi-leaf collimators has been further extended toMarch 31, 2021 . One additional exclusion request, for tungsten shielding, was not extended and expired onSeptember 19, 2020 . In June andJuly 2019 , we submitted formal requests to the Chinese government for exclusions from the Chinese retaliatory tariffs for manufacturing inputs, service parts and radiotherapy systems imported intoChina fromthe United States . InSeptember 2019 , the Chinese government granted a tariff exclusion for medical linear accelerators, including our radiotherapy systems, which was extended throughSeptember 16, 2021 . We utilize a monthly exclusion program to further mitigate the tariffs on other items. In the aggregate, these tariffs will be referred to as "U.S. /China tariffs." Restructuring Charges. In the third quarter of fiscal year 2020, we implemented a global workforce reduction, as part of our plan to enhance operational performance through productivity initiatives, in response to the impact of the COVID-19 pandemic. The Company incurred$0.7 million in restructuring charges in the first quarter of fiscal year 2021, which primarily consisted of employee severance costs. We paid$3.0 million for restructuring charges in the first quarter of fiscal year 2021. The restructuring accrual balance atJanuary 1, 2021 was$4.4 million , and it is expected to be paid in fiscal year 2021. As ofJanuary 1, 2021 , we do not expect to incur additional restructuring charges under this plan. The restructuring charges are included in selling, general and administrative in the Condensed Consolidated Statements of Earnings. 37 -------------------------------------------------------------------------------- Currency Fluctuation. In order to assist with the assessment of how our underlying businesses performed, we compare the percentage change in revenues and Oncology Systems gross orders from one period to another, excluding the effect of foreign currency fluctuations (i.e., using constant currency exchange rates). To present this information on a constant currency basis, we convert current period revenues and gross orders in currencies other thanU.S. Dollars intoU.S. Dollars using the comparable prior period's average exchange rate. Percentage changes in revenues and gross orders are not adjusted for constant currency unless indicated. Currency fluctuations had approximately a$12 million favorable impact for total revenues and a$11 million favorable impact for Oncology Systems gross orders, respectively, for the three months endedJanuary 1, 2021 , compared to the year-ago period. We expect that fluctuations of non-U.S. Dollar currencies against theU.S. Dollar may continue to cause variability in our financial performance. Our Businesses Oncology Systems. Our Oncology Systems business designs, manufactures, sells and services hardware and software products for treating cancer with conventional radiotherapy, and advanced treatments such as fixed field intensity-modulated radiation therapy ("IMRT"), image-guided radiation therapy ("IGRT"), volumetric modulated arc therapy ("VMAT"), stereotactic radiosurgery, stereotactic body radiotherapy, artificial intelligence based Adaptive Radiotherapy and brachytherapy as well as associated quality assurance equipment. Our software solutions include treatment planning, informatics, clinical knowledge exchange, patient care management, practice management and decision support for comprehensive cancer clinics, radiotherapy centers and medical oncology practices. We offer services ranging from hardware phone support, break/fix repair of linear accelerators, obsolescence protection of hardware, software support, software upgrades, hosting as a service, as well as clinical consulting services. We have expanded our services offerings to include clinical practice services that assist within the clinical workflow. These services focus on decision support and/or cancer care knowledge augmentation aimed to facilitate improved accessibility and affordability to care while maintaining a fundamental level of clinical quality. Further, the Company operates 13 multi-disciplinary cancer centers and one specialty hospital inIndia and one multi-disciplinary cancer center inSri Lanka . We also expect to innovate and incubate new solutions such as technology-enabled services, and to develop additional technologies that incorporate artificial intelligence and machine learning capabilities, in an environment of data security and patient privacy integrity. Our primary goal in the Oncology Systems business is to promote the adoption of more advanced and effective cancer treatments. In our view, the fundamental market forces that drive long-term growth in our Oncology Systems business are the rise in cancer cases; technology advances and product developments that are leading to improvements in patient care and outcomes; customer demand for the more advanced and effective cancer treatments that we enable; competitive conditions among hospitals and clinics to offer such advanced treatments; continued improvement in safety and cost efficiency in delivering radiation therapy; and underserved medical needs outside ofthe United States . Approximately half of Oncology Systems gross orders and revenues come from international markets, within which certain emerging markets typically can have lower gross margins and longer installation cycles since many of these purchases are for new sites where treatment vaults need to be constructed. We have also been investing a higher portion of our Oncology Systems research and development budget in software and software-related products, which have a higher gross margin than our hardware products. Subject to the potential impact of COVID-19, we believe international markets will be our fastest growing markets. The radiation oncology market inNorth America is largely characterized by the replacements of older machines, with periodic increases in demand driven by the introduction of new technologies. Reimbursement rates inthe United States have generally supported a favorable return on investment for the purchase of new radiotherapy equipment and technologies. While we believe that improved product functionality, greater cost-effectiveness and prospects for better clinical outcomes with new capabilities, such as IMRT, IGRT and VMAT, tend to drive demand for radiotherapy products, large changes in reimbursement rates or reimbursement structure can affect customer demand and cause market shifts. We believe that growth of the radiation oncology market inthe United States could be impacted as customers' decision-making processes are complicated by the uncertainties surrounding reimbursement rates and new models for radiotherapy and radiosurgery, such as the final rule for the alternative payment model pilot program for radiation oncology, which was released by theCenters for Medicare and Medicaid Innovation Center inSeptember 2020 . This pilot program is scheduled to commence onJanuary 1, 2022 , and is intended to test whether an episode-based payment structure would reduce Medicare expenditures. We believe that this uncertainty will likely continue in future fiscal years and could impact transaction size, timing and purchasing processes, and also contribute to increased quarterly business variability as customers recover from the COVID-19 pandemic. 38 -------------------------------------------------------------------------------- Global demand for oncology equipment varies by geography and size of cancer burden. The number of new cancer cases diagnosed annually is projected to increase from approximately 18 million in 2018 to almost 25 million by 2030. Markets such asNorth America , developedEurope andJapan are primarily replacement markets with growth consistent with the aging cycle of the installed base and the aging of populations. Emerging markets such asBrazil ,Russia ,India ,China andAfrica have large gaps in access to care and are expected to grow faster to address this gap. Variations in spend on oncology equipment will occur over time based on economic factors in individual countries. Proton Solutions. Our Proton Solutions business develops, designs, manufactures, sells and services products and systems for delivering proton therapy, another form of external beam therapy using proton beams, for the treatment of cancer. Proton therapy is a preferred option for treating certain cancers, particularly tumors near critical structures such as the base of the skull, spine, optic nerve and most pediatric cancers. Although proton therapy has been in clinical use for more than four decades, it has not been widely deployed due to the high capital cost. We are investing resources to drive growth and innovation in this business. Proton therapy facilities are large-scale construction projects that have long lead times and involve significant customer investment and often complex project financing. Consequently, this business is vulnerable to general economic and market conditions, as well as reimbursement rates. Customer decision-making cycles tend to be very long, and orders generally involve many contingencies. The funding environment for large capital projects, such as proton therapy projects, remains challenging and volatile. Our current focus is bringing our expertise in traditional radiation therapy to proton therapy to improve its clinical utility, reduce its cost of treatment per patient and drive innovation, so that it is more widely accepted and deployed. As ofJanuary 1, 2021 , we had a carrying value of$121.5 million of notes receivable, including accrued interest, senior secured debt, available-for-sale securities, and loans outstanding to Proton Solutions customers. See Note 14, "Proton Solutions Loans and Investments," of the Notes to the Condensed Consolidated Financial Statements for further information. Other. The Other category includes our Interventional Solutions business that offers products for interventional oncology and interventional radiology procedures and treatments, including cryoablation, microwave ablation and embolization. We also provide software and remote services for post treatment dose calculation for Yttrium-90 microspheres used in selective internal radiation therapy. Our goal is to offer a wide range of innovative products to the global oncology and radiology markets through a direct sales force and a network of distributors. Critical Accounting Estimates The preparation of our financial statements and related disclosures in conformity with accounting principles generally accepted inthe United States ("GAAP") requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates and assumptions are based on historical experience and on various other factors that we believe are reasonable under the circumstances. Our critical accounting policies that are affected by accounting estimates require us to use judgments, often as a result of the need to make estimates and assumptions regarding matters that are inherently uncertain, and actual results could differ materially from these estimates. We periodically review our accounting policies, estimates and assumptions and make adjustments when facts and circumstances dictate. During the three months endedJanuary 1, 2021 , there were no significant changes except as noted below to our critical accounting policies and estimates as described in the financial statements contained in Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 2020 Annual Report. Allowance for Credit Losses We evaluate the creditworthiness of our customers prior to authorizing shipment for all major sale transactions. Except for government tenders, group purchases and orders with letters of credit in Oncology Systems, our payment terms often require payment of a small portion of the total amount due when the customer signs the purchase order, a significant amount upon transfer of risk of loss to the customer and the remaining amount due upon completion of the installation. Following the adoption of ASU 2016-13, we record credit loss reserves to allowance for credit losses when we establish a trade or unbilled accounts receivable, if credit losses are expected over the asset's contractual life. We generally base our estimates of credit loss reserves on historical experience and adjust, as necessary, to reflect current conditions using reasonable and supportable forecasts not already reflected in the historical loss information. Further, on a quarterly basis, we evaluate aged items in our accounts receivable aging report and, if necessary, record an additional allowance in an amount we deem adequate for credit losses. If our evaluation of our customers' financial conditions does not reflect our future ability to collect outstanding receivables, additional provisions may be needed, and our operating results could be negatively affected. 39 -------------------------------------------------------------------------------- Results of Operations Fiscal Year Our fiscal year is the 52- or 53-week period ending on the Friday nearestSeptember 30 . Fiscal year 2021 is the 52-week period endingOctober 1, 2021 , and fiscal year 2020 was the 53-week period that endedOctober 2, 2020 . The fiscal quarter endedJanuary 1, 2021 was a 13-week period and the fiscal quarter endedJanuary 3, 2020 was a 14-week period. Discussion of Results of Operations for the Three Months EndedJanuary 1, 2021 Compared to the Three Months EndedJanuary 3, 2020 Total Revenues Revenues by sales classification Three Months Ended January 1, January 3, (Dollars in millions) 2021 2020 Percent Change Product $ 364.2 $ 421.0 (13) % Service 414.6 407.9 2 % Total Revenues $ 778.8 $ 828.9 (6) % Product as a percentage of total revenues 47 % 51 % Service as a percentage of total revenues 53 % 49 % Total product revenues decreased in the three months endedJanuary 1, 2021 , compared to the year-ago period, mostly driven by a decline in hardware product revenues from Oncology Systems due to the inability to access sites and delays to pre-installation construction activities caused by COVID-19 restrictions and, to a lesser extent, decreases in product revenues from the Other category and Proton Solutions. Total service revenues increased in the three months endedJanuary 1, 2021 , compared to the year-ago period, primarily due to an increase in service revenues from Oncology Systems driven by a larger install base, and from Proton Solutions as more proton centers transition to service contracts. The increase was partially offset by approximately$19 million in additional service revenues from Oncology Systems in the three months endedJanuary 3, 2020 due to it being a 14-week period. Revenues by geographical region
Three Months Ended
January 1, January 3,
(Dollars in millions) 2021 2020 Percent Change Constant Currency
Americas $ 349.0 $ 402.2 (13) % (13) %
EMEA 267.6 272.9 (2) % (5) %
APAC 162.2 153.8 5 % 2 %
Total Revenues $ 778.8 $ 828.9 (6) % (8) %
North America (1) $ 329.6 $ 378.5 (13) % (13) %
International 449.2 450.4 - % (3) %
Total Revenues $ 778.8 $ 828.9 (6) % (8) %
North America as a percentage of total
revenues 42 % 46 %
International as a percentage of total
revenues 58 % 54 %
(1)North America primarily includesthe United States andCanada . TheAmericas region revenues decreased in the three months endedJanuary 1, 2021 , compared to the year-ago period, primarily due to an increase in Oncology Systems and, to a lesser extent, decreases in Proton Solutions and the Other category. The EMEA region revenues decreased in the three months endedJanuary 1, 2021 , compared to the year-ago period, primarily due to a decrease in Oncology Systems. The APAC region revenues increased in the three months endedJanuary 1, 2021 , as 40 -------------------------------------------------------------------------------- compared to the prior period, primarily due to an increase Oncology Systems, partially offset by a decrease in the Other category. Oncology Systems Revenues Revenues by sales classification
Three Months Ended
January 1, January 3,
(Dollars in millions) 2021 2020 Percent Change Constant Currency
Product $ 338.5 $ 382.0 (11) % (13) %
Service 406.0 400.4 1 % - %
Total Oncology Systems Revenues $ 744.5 $ 782.4 (5) % (6) %
Product as a percentage of total Oncology
Systems revenues 45 % 49 %
Service as a percentage of total Oncology
Systems revenues 55 % 51 %
Oncology Systems revenues as a percentage of
total revenues 96 % 95 %
Oncology Systems product revenues decreased in the three months endedJanuary 1, 2021 , compared to the year-ago period, primarily driven by a decline in hardware product revenues due to the inability to access sites and delays to pre-installation construction activities caused by COVID-19 restrictions. Oncology Systems service revenues, which include performance obligations for installation, training and warranty, increased in the three months endedJanuary 1, 2021 , compared to the year-ago period, primarily due to an increase in the number of customers as the installed base of our products continues to grow. The increase was partially offset by approximately$19 million in additional service revenues in the three months endedJanuary 3, 2020 , due to it being a 14-week period. Revenues by geographical region
Three Months Ended
January 1, January 3,
(Dollars in millions) 2021 2020 Percent Change Constant Currency
Americas $ 332.5 $ 378.9 (12) % (12) %
EMEA 254.2 259.8 (2) % (5) %
APAC 157.8 143.7 10 % 6 %
Total Oncology Systems Revenues $ 744.5 $ 782.4 (5) % (6) %
North America $ 313.1 $ 355.2 (12) % (12) %
International 431.4 427.2 1 % (2) %
Total Oncology Systems Revenues $ 744.5 $ 782.4 (5) % (6) %
North America as a percentage of total
Oncology Systems revenues 42 % 45 %
International as a percentage of total
Oncology Systems revenues 58 % 55 %
In the first quarter of fiscal year 2021, Oncology Systems revenues for hardware products were impacted across all regions by the inability to access sites and delays to pre-installation construction activities caused by COVID-19 restrictions. Oncology Systems revenues decreased in theAmericas region in the three months endedJanuary 1, 2021 , compared to the year-ago period, primarily due to a decrease in hardware product revenues. Oncology Systems revenues decreased in the EMEA region in the three months endedJanuary 1, 2021 , compared to the year-ago period, primarily due to decreases in revenues from hardware products and software licenses, partially offset by an increase in revenues from services. Oncology Systems revenues from the APAC region increased in the three months endedJanuary 1, 2021 , compared to the year-ago period, primarily due an increase in revenues from hardware products and, to a lesser extent, an increase in revenues from services. Variations of higher and lower revenues between theNorth America and international regions are impacted by regional factors influencing our gross orders, which include the impact of COVID-19, government spending, philanthropy/donations, timing of replacement or new site expansions, economic and political instability in some countries, uncertainty created byU.S. health care policy, such as the possibility for bundled reimbursement payments and accountable care organizations, Medicare 41 -------------------------------------------------------------------------------- reimbursement rates and consolidation of free standing clinics inthe United States , and different technology adoption cycles. See further discussion of orders under "Gross Orders." Proton Solutions Revenues Revenues by sales classification Three Months Ended January 1, January 3, (Dollars in millions) 2021 2020 Percent Change Product $ 17.0 $ 20.1 (16) % Service 8.6 7.5 15 % Total Proton Solutions Revenues $ 25.6 $ 27.6 (7) % Proton Solutions revenues as a percentage of total revenues 3 % 3 % Proton Solutions revenues decreased in the three months endedJanuary 1, 2021 , compared to the year-ago period, primarily due to the timing of project completion and stage of progress that was partially due to COVID-19, partially offset by an increase in service revenues resulting from the increase in the number of proton centers which transitioned to service contracts. Other Revenues Revenues from the Other category decreased$10.2 million for the three months endedJanuary 1, 2021 , primarily driven by lower volumes from distributors inChina . This business is still developing and is subject to variability in order and revenue patterns, driven in part by distributors. Gross Margin Dollars by segment Three Months Ended January 1, January 3, (Dollars in millions) 2021 2020 Percent Change Oncology Systems $ 353.1 $ 353.0 - % Proton Solutions 0.5 - n/m Other 5.4 13.8 (61) % Gross margin $ 359.0 $ 366.8 (2) % Percentage by segment Oncology Systems 47.4 % 45.1 % Proton Solutions 1.8 % n/m Other 62.0 % 72.8 %Total Company 46.1 % 44.2 % Percentage by sales classificationTotal Company - Product 32.7 % 35.4 %Total Company - Service 57.9 % 53.4 % Oncology Systems - Product 35.0 % 36.1 % Oncology Systems - Service 57.8 % 53.7 % n/m - not meaningful Oncology Systems product gross margin percentage decreased in the three months endedJanuary 1, 2021 , compared to the year-ago period, primarily due to portfolio and geographic mix. Oncology Systems service gross margin percentage increased in the three months endedJanuary 1, 2021 , compared to the year-ago period, primarily due to lower installation and travel costs due to COVID-19. Proton Solutions gross margin percentage increased in the three months endedJanuary 1, 2021 , compared to the year-ago period, primarily due to the mix of projects and an increase in service revenues. Other category gross margin percentage decreased in the three months endedJanuary 1, 2021 , compared to the year-ago period, partially due to the write-off of expired inventory. 42 --------------------------------------------------------------------------------
Research and Development
Three Months Ended
January 1, January 3,
(Dollars in millions) 2021 2020 Percent Change
Research and development $ 72.2 $ 67.1 8 %
Research and development as a percentage of total revenues 9 % 8 %
Research and development expenses increased $5.1 million in the three months
ended January 1, 2021 , compared to the year-ago period, primarily due to an
increase in investments in software, flash technology, adaptive radiotherapy and
other strategic programs.
Selling, General and Administrative and Acquisition-related expenses
Three Months Ended
January 1, January 3,
(Dollars in millions) 2021 2020 Percent Change
Selling, general and administrative $ 161.9 $ 177.0 (9) %
Acquisition-related expenses $ 7.7 $ 12.7 (40) %
Selling, general and administrative as a percentage of total revenues
21 % 21 %
Acquisition-related expenses as a percentage of total revenues 1 % 2 %
Selling, general and administrative expenses decreased $15.1 million in the
three months ended January 1, 2021 , compared to the year-ago period, primarily
due to cost-saving measures that were put in place in the second half of fiscal
year 2020 due to the COVID-19 pandemic.
Acquisition-related expenses in the three months ended January 1, 2021 ,
primarily includes $4.9 million in transactions costs for advisory fees related
to the proposed acquisition by Siemens Healthineers. Acquisition-related
expenses in the three months ended January 3, 2020 , primarily includes an $8.8
million increase in the fair value of contingent consideration related to the
Endocare and Alicon acquisitions in fiscal year 2019.
Other Income, Net
Three Months Ended
January 1, January 3,
(Dollars in millions) 2021 2020 Percent Change
Interest income $ 2.8 $ 3.0 (4) %
Interest expense $ (1.3) $ (4.7) (72) %
Other income, net $ 5.7 $ 4.4 31 %
Interest income decreased in the three months ended January 1, 2021 , compared to
the year-ago period, primarily due to lower income generated from our cash
balances due to a decrease in interest rates. Interest expense decreased in the
three months ended January 1, 2021 , compared to the year-ago period, primarily
due to a decrease in borrowings on our Credit Facility. Other income, net,
increased in the three months ended January 1, 2021 , compared to the year-ago
period, primarily due to $8.6 million that was mostly due to increases in the
fair value of our equity investments, partially offset by $3.8 million in
foreign exchange losses.
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Taxes on Earnings
Three Months Ended
January 1, January 3,
(Dollars in millions) 2021 2020 Change
Taxes on earnings $ 27.6 $ 23.8 17.0 %
Effective tax rate 22.2 % 21.0 %
Our effective tax rate is higher in the three months ended
Our effective tax rate is impacted by the percentage of our total earnings that comes from our international regions, the mix of particular tax jurisdictions within our international regions, changes in the valuation of our deferred tax assets or liabilities, and changes in tax laws or interpretations of those laws. We expect that our effective tax rate may experience increased fluctuations from period to period. See Note 10, "Income Taxes," of the Notes to the Consolidated Financial Statements in our 2020 Annual Report.
Net Earnings Per Diluted Share
Three Months Ended
January 1, January 3,
2021 2020 Percent Change
Diluted net earnings per share $ 1.05 $ 0.96 9 %
Net earnings per diluted share increased in the three months endedJanuary 1, 2021 , compared to the year-ago period, primarily due to an increase in operating earnings, gains from equity investments, partially offset by an increase in the effective tax rate in the first quarter of fiscal year 2021.
Gross Orders
Gross orders by segment Three Months Ended
January 1, January 3,
(Dollars in millions) 2021 2020
Percent Change
Oncology Systems $ 789.4 $ 773.8 2 %
Proton Solutions 55.6 25.9 114 %
Other 8.7 18.9 (54) %
Total Gross Orders $ 853.7 $ 818.6 4 %
n/m - not meaningful
Gross orders are defined as new orders recorded during the period and revisions
to previously recorded orders. New orders are recorded for the total contractual
amount, excluding certain pass-through items and service items, which are
recognized as revenue is recognized, once a written agreement for the delivery
of goods or provision of services is in place and, other than Proton Solutions,
when shipment of the product is expected to occur within two years, so long as
any contingencies are deemed perfunctory. For our Proton Solutions business, we
record orders when construction of the related proton therapy treatment center
is reasonably expected to start within two years, but only if any contingencies
are deemed perfunctory. We will not record Proton Solutions orders if there are
financing contingencies, if a substantial portion of the financing for the
project is not reasonably assured or if customer board approval contingencies
are pending. We perform a quarterly review to verify that outstanding orders
remain valid. If an order is no longer expected to ultimately convert to
revenue, we record a backlog adjustment, which reduces backlog but does not
impact gross orders for the period.
Gross orders in any period may not be directly correlated to the level of
revenues in any particular future quarter or period since the timing of revenue
recognition will vary significantly based on the delivery requirements of
individual orders, acceptance schedules and the readiness of individual customer
sites for installation of our products, all of which was impacted by COVID-19.
Moreover, certain types of orders, such as orders for software or newly
introduced products in our Oncology Systems segment, typically take more time
from order to completion of installation and acceptance than hardware or older
products. Because an order for a proton therapy system can be relatively large,
an order in one fiscal period will cause gross orders in our Proton Solutions
business to vary significantly, making comparisons between fiscal periods more
difficult.
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Oncology Systems Gross Orders
Gross orders by geographical region Three Months Ended
January 1, January 3,
(Dollars in millions) 2021 2020 Percent Change Constant Currency
Americas $ 346.9 $ 359.5 (4) % (3) %
EMEA 286.0 236.7 21 % 18 %
APAC 156.5 177.6 (12) % (14) %
Total Oncology Systems Gross Orders $ 789.4 $ 773.8 2 % 1 %
North America $ 325.5 $ 326.8 - % (1) %
International 463.9 447.0 4 % 1 %
Total Oncology Systems Gross Orders $ 789.4 $ 773.8 2 % 1 %
The Americas Oncology Systems gross orders decreased in the three months ended
January 1, 2021 , compared to the year-ago period, primarily due to a decrease in
hardware and software product orders. EMEA Oncology Systems gross orders
increased in the three months ended January 1, 2021 , compared to the year-ago
period, primarily due to an increase in hardware product orders. APAC Oncology
Systems gross orders decreased in the three months ended January 1, 2021 ,
compared to the year-ago period, primarily due to a decrease in hardware and
software product orders.
The trailing 12 months' growth in gross orders for Oncology Systems at the end
of the first quarter of fiscal year 2021 and at the end of each of the previous
three fiscal quarters was:
Trailing 12 Months Ended
January 1, October 2, July 3, April 3,
2021 2020 2020 2020
Americas (9)% (7)% 2% 4%
EMEA (3)% (6)% (1)% 9%
APAC -% 6% (1)% (2)%
North America (8)% (7)% 2% 3%
International (4)% (2)% (1)% 5%
Total Oncology Systems Gross Orders (5)% (4)% 1% 5%
Consistent with the historical pattern, we expect that Oncology Systems gross
orders will continue to experience regional fluctuations. We expect that that
customer financial constraints, foreign currency headwinds, and uncertainty
around the COVID-19 pandemic may lead our customers to continue to defer capital
equipment purchases for a significant portion of fiscal year 2021, which will
have an adverse effect on Oncology Systems gross orders in fiscal year 2021.
Over the long-term, we expect international gross orders, specifically from
emerging markets, will grow as a percentage of overall orders. Oncology Systems
gross orders are affected by foreign currency fluctuations, which could impact
the demand for our products. In addition, government programs that stimulate the
purchase of healthcare products could affect the demand for our products from
period to period, and could therefore make it difficult to compare our financial
results.
Proton Solutions Gross Orders
Proton Solutions gross orders increased $29.7 million in the three months ended
January 1, 2021 , compared to the year-ago period, mostly due to a larger proton
therapy system order in the first quarter of fiscal year 2021 compared to the
prior year period.
Other Category Gross Orders
The Other category gross orders decreased $10.2 million in the three months
ended January 1, 2021 , compared to the year-ago period, primarily driven by
lower volumes from distributors in China . This business is still developing and
is subject to variability in order and revenue patterns, driven in part by
distributors. Gross orders from the Other category are related to our
Interventional Solutions business.
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--------------------------------------------------------------------------------Backlog
Backlog is the accumulation of all gross orders for which revenues have not been recognized but are still considered valid. Backlog is stated at historical foreign currency exchange rates and revenue is released from backlog at current exchange rates, with any difference recorded as a backlog adjustment. AtJanuary 1, 2021 , total Company backlog was$3.4 billion , an increase of 2% compared to the backlog atJanuary 3, 2020 . Our Oncology Systems backlog atJanuary 1, 2021 was 1% higher than the backlog atJanuary 3, 2020 , which reflected an increase of 7% from our international region, offset by a decrease of 6% from ourNorth America region. Proton Solutions backlog was approximately$263 million atJanuary 1, 2021 . We perform a quarterly review to verify that outstanding orders in the backlog remain valid. Aged orders that are not expected to ultimately convert to revenues are deemed dormant and are reflected as a reduction in the backlog amounts in the period identified. Backlog adjustments are comprised of dormancies, cancellations, foreign currency exchange rate adjustments, backlog acquired from our acquisitions, and other adjustments. Gross orders do not include backlog adjustments. Backlog adjustments totaled a net reduction of$88.1 million in the three months endedJanuary 1, 2021 , compared to a net reduction of$74.5 million in the year-ago period. Liquidity and Capital Resources Liquidity is the measurement of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, acquire businesses or make other investments or loans, repurchase shares of VMS common stock, and fund continuing operations and capital expenditures. Our sources of cash have included operations, borrowings, stock option exercises, and employee stock purchases. Cash, Cash Equivalents, and Restricted Cash The following table summarizes our cash, cash equivalents, and restricted cash: January 1, October 2, (In millions) 2021 2020 Increase Cash and cash equivalents$ 773.3 $ 766.1 $ 7.2 Restricted cash 19.8 19.7 0.1
Total cash, cash equivalents, and restricted cash
The increase in cash, cash equivalents, and restricted cash in the three months endedJanuary 1, 2021 was primarily due to$141.4 million of cash provided by operating activities,$52.4 million in proceeds from the issuance of common stock to employees, partially offset by$145.0 million in net repayments on our credit facility,$16.8 million used for purchases of property, plant, and equipment,$10.3 million for the purchase of equity investments and notes receivable in privately-held companies, and$7.6 million used for tax withholdings on vesting of equity awards. AtJanuary 1, 2021 , we had approximately$213 million , or 28%, of cash and cash equivalents inthe United States , which includes approximately$87 million in money market funds, and approximately$561 million , or 72%, of cash and cash equivalents was held abroad. In light of the changes to theU.S. federal taxation of foreign earnings in the Act, we no longer consider the earnings of our foreign subsidiaries to be indefinitely reinvested. As a result, we have accrued for the foreign and state income taxes that we expect would be imposed upon a future remittance. As ofJanuary 1, 2021 , most of our cash and cash equivalents that were held abroad were inU.S. Dollars and were primarily held as bank deposits. In addition to cash flows generated from operations, a significant portion of which are generated inthe United States , we have used our credit facilities to meet our cash needs from time to time and expect to continue to do so in the future. Borrowings under our credit facilities may be used for working capital, capital expenditures, VMS share repurchases, acquisitions and other corporate purposes. 46
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