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Varian Medical Systems (VAR - Analyst Report) posted third-quarter fiscal 2013 net earnings of $1.03 per share beating the Zacks Consensus Estimate by a couple of cents. The result was also significantly better than the year-ago net earnings of 96 cents and the company’s previously announced guidance of net earnings in the range of 98 cents to $1.02 per share for the reported quarter.

Net earnings improved 3.7% year over year to $112.8 million in the third fiscal quarter.

Revenues & Orders

In the third quarter, revenues increased 3% year over year to $726.2 million, well short of the Zacks Consensus Estimate of $753 million. It also missed Varian’s expectations of 7% sales growth in the quarter.

Order backlog rose 4% year over year to $ 2,752.8 million at the end of the reported quarter. Net orders grew 5.4% year over year to $726.5 million.

Segment Review

Revenues from Oncology Systems increased 3% year over year to $561.3 million in the third quarter. Net orders for the core segment rose 4% (up 6% at constant exchange rate or CER) to $582 million, as 8% order growth outside North America (up 12% at CER) was partly offset by a 1% downfall in North American orders.

Overseas sales (contributed 57% to net orders for this segment) were primarily driven by a 21% jump (up 22% at CER) in Europe, Middle East and Africa (EMEA). The double-digit growth in net orders was attributed to strong demand from high focus Asian countries like China and Japan, where orders rose over 20%. The company also did well in North Africa, Turkey, Poland and UK. However, Varian faced currency headwinds in the Asian market. On the other hand, the decline in North American market was due to a tough capital spending environment due to looming concerns regarding healthcare reforms and reimbursement scenario.

Revenues for X-Ray Products segment in the quarter came in at $135.3 million, up 7% year over year. Net orders for the products inched up 2% to $122.7 million. Despite double-digit growth for flat panel business, this segment was adversely affected by the reduction in inventory levels for its X-ray tube by Japanese customers.

Revenues from the Other category decreased about 8% from the comparable year-ago quarter to $29.6 million in the reported quarter. Net orders for the category increased almost three-folds to $21.8 million.

Margins

Gross margin in the quarter was 42.8%, down 80 basis points (bps) year over year. Selling, general and administrative expense decreased 2.7% from the year-ago quarter to $102.4 million. Research and development expenditure increased 9.2% year over year to $53.4 million. Operating margin contracted 50 bps at 21.3%.

Balance Sheet

Varian exited the quarter with cash and cash equivalents and short term investments of $825 million compared with $754.3 million at the end of fiscal 2012. Long-term debt (including current maturities) was nil compared with $6.3 million at the end of fiscal 2012.

The company generated operating cash flow of $198 million, a record high for Varian. It repurchased shares worth $95 million during the quarter.

Outlook

Following the third quarter, Varian revised its expectations for fiscal 2013. Moving ahead, the company envisages revenues to grow by about 5% for fiscal 2013 compared with the prior outlook of 8% sales growth.

Net earnings for fiscal 2013 was lowered to the band of $4.00–$4.04 per share compared with the earlier guidance of $4.09–$4.14. The current Zacks Consensus Estimate of $4.10 lies above the guided range. Per management, the guidance revision reflects the sharp downfall in the yen and uncertainty related to the realization of revenues from the proton therapy project in Maryland.

Our View

Apart from the upbeat earnings that edged past the Zacks Consensus Estimate, Varian reported an otherwise disappointing quarter. While sales growth lagged the company’s expectations and the Zacks Consensus Estimate, it also lowered its outlook for the ongoing fiscal. The revised guidance also trailed the Zacks Consensus Estimate. Margin contraction was also an area of concern. As a result, the stock tanked over 5% in after-hours trading.

Varian’s Oncology Systems franchise continued to struggle in the North American market on account of uncertainty emanating from health care reform and anticipated changes in reimbursement. Until the overall scenario stabilizes, we prefer to avoid the stock as Varian carries a Zacks Rank #4 (Sell).

Other medical stocks such as IDEXX Laboratories Inc. (IDXX - Analyst Report), Globus Medical Inc. (GMED - Snapshot Report) and Thoratec Corp. (THOR - Analyst Report) are likely to do well. These stocks carry a Zacks Rank #2 (Buy).

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