Note to Reader: This report contains substantially new material. Subsequent reports will have changes highlighted.
Reason for Report: 4Q09 and FY09 Earnings Update
Prev. Ed.: September 23, 2009; Minor News Update (brokers’ material are as of Sept. 22)
Brokers’ Recommendations: Neutral: 67.0% (2 firms); Negative: 0.0%; Positive: 0.0%;Not Rated: 33.0%(1)
Prev. Ed.: 3; 0; 0; 0
Brokers’ Target Price: $52.00 (↔ with the last edition; 2 firms) Brokers’ Avg. Expected Return: 2.0%
*Note: Though dated November 17, share price and brokers’ material are as of November 13.
Note: A Flash Update on 4Q09 and FY09 Earnings was done on November 4
Note: The tables below (Revenue, Margins, and Earnings per Share) contain less brokers’ material than the brokers’ material used in the Valuation table. The extra figures in the Valuation table come from reports that did not have accompanying spreadsheet models.
Portfolio Manager Executive Summary
Varian, Inc. (VARI) designs, develops, and manufactures a wide range of instrument systems and related consumables for analytical chemists across diverse applications. Its emphasis is on information rich detection (IRD) instruments—mass-spec, magnetic resonance, FT-IR—that make up about 40% of its sales. VARI is also a leading provider of vacuum systems for creating ultra-clean vacuum environments in life science and industrial applications. About 60% of its sales come from economically sensitive Industrial end markets and 40% from the health care/life science industry.
Of the three firms, 67% (2 firms) gave Neutral ratings and 33%(I firm) did not provide any rating.
Neutral or equivalent outlook (2/3): Target price of $52.00. Overall, these analysts believe that Agilent, which has an agreement to acquire VARI, will benefit from VARI’s Bio Analytical Measurement platform and more specifically its life sciences, academic, and government end market exposure. These analysts, however, believe that VARI's markets are highly competitive and some of its end markets are sensitive to economic cyclicality. The analysts are encouraged by the substantial margin growth opportunity for VARI, its positive and sustainable operating performance in recent quarters, its attractive relative valuation, the durability of its nuclear magnetic resonance (NMR) franchise, and the utility of its technology in drug discovery and development. Looking ahead, these analysts believe that VARI is capable of generating mid-teens EPS growth over the longer term. However, these analysts remain skeptical about VARI’s ability to continually develop new products and improve its existing products, which could materially affect its results. The estimated return over the current share price is 2.0%.
November 17, 2009
Recent Events
On November 4, 2009, VARI announced its 4Q09 and FY09 financial results. Highlights are as follows:
Ø Revenue was $196.5 million in 4Q09, down 30.4% y/y. In FY09, revenue was $806.7 billion versus $1.013 billion in FY08, down 20.3% y/y.
Ø Non GAAP EPS was $0.40 in 4Q09 versus $0.78 in 4Q08. In FY09, Non GAAP EPS was $2.01 versus $2.62 in FY08.
On October 6, 2009, VARI announced that at a special meeting of stockholders held on October 5, 2009, its stockholders adopted the merger agreement entered into with Agilent Technologies, Inc. For more details, refer to the “Other” segment of this report.
Overview
The analysts identified the following issues for evaluating the investment merits of VARI:
Key Positive Arguments / Key Negative ArgumentsCompetitive Position – VARI maintains the leading position in console and magnet design for information-rich detection systems.
Diverse Product Offering – By offering a broad technological product portfolio, VARI is a one-stop shop for its customers. Its product portfolio leaves it well positioned to benefit from the continued healthy end market growth.
Superior Free Cash Flow/Balance Sheet – VARI delivers exceptional free cash flow as its net income conversion rate trended above 100% in recent years. It retains the flexibility to fund acquisitions and/or repurchase share.
Life Science Growth – Varian expanded its exposure to life sciences and health care end markets from 29% in 1999 to approximately 40% presently, and is expected to continue to focus on the higher-growth life sciences markets going forward.
Operational Improvements – Recent acquisitions, ongoing operational improvements, and continued share buybacks would support further revenue and EPS growth. / Cyclical Exposure – Varian’s significant exposure to cyclical industries increases the company’s vulnerability to poor macroeconomic conditions. VARI derives more than half of its revenue from outside North America, and negative foreign currency translation rates can affect its revenue and earnings significantly.
Technological Obsolescence – The company operates in an industry that is highly dependent on continued innovation and product development. If Varian is unable to continue with new product development and product improvements, its results could be materially affected.
Government Funding – VARI’s products are often funded by government agencies. Any decline in government funding for research could have an adverse impact on VARI’s sales and EPS.
Acquisition – Growth through acquisitions is one of VARI’s key strategies. A lack of acquisition candidates or a failure to properly retain key employees or properly integrate an acquisition could materially impact VARI’s results.
Based in Palo Alto, California, Varian, Inc. (VARI), along with its subsidiaries, engages in the design, development, manufacture, sale, and service of scientific instruments, and vacuum products. It operates through two segments: Scientific Instruments and Vacuum Technologies. VARI’s products include diffusion, turbo molecular, and ion getter vacuum pumps; rotary vane, sorption, and dry scroll vacuum pumps; vacuum control instruments, sensor gauges, and meters; valves, flanges, other mechanical hardware, and helium mass spectrometry; and helium-sensing leak detection equipment. These products are used in various applications, including manufacture of flat-panel displays, television tubes, decorative coating, and semiconductors; life sciences applications; food packaging; testing of aircraft components; and high-energy physics research. Additional information about the company is available at www.varianinc.com.
Note: The company’s fiscal year ends on September 30; fiscal references do not coincide with the calendar year.
November 17, 2009
Revenue
VARI reported 4Q09 revenue of $196.5 million, a decrease of 30.4% y/y. In FY09, revenue was $806.7 million, down 20.3% from $1.013 billion in FY08. The Zacks Digest average 4Q09 and FY09 revenue was in line with the company report.
Orders exceeded revenues by approximately $9 million in 4Q09. The revenue shortfall was primarily due to the global economic downturn, customer uncertainty and other disruptions related to the announced acquisition by Agilent.
Provided below is a summary of total revenue as compiled by Zacks Digest:
Revenue ($M) / 4Q08A / 2008A / 4Q09A / 2009A / 1Q10E / 4Q10E / 2010E / 2011E / 2012ETotal Revenue / $282.6 / $1,012.4 / $196.5 / $806.7 / $850.0↓
Digest High / $283.0 / $1,012.5 / $196.5 / $806.7 / $850.0 ↓
Digest Low / $282.5 / $1,012.0 / $196.5 / $806.7 / $850.0 ↓
YoY Growth / 15.0% / 10.0% / -30.5% / -20.3% / 5.4%↑
Segment Discussion
VARI has two business segments: Scientific Instruments and Vacuum Technologies.
Scientific Instruments
VARI manufactures high-performance products, such as consumable supplies and solutions, which are key tools in bio-molecular and academic research, pharmaceutical R&D and manufacturing, and industrial R&D and quality control, and are also used to develop a variety of products – from disease-resistant crops to cosmetics to testing drinking water and monitoring quality in the petrochemical industry. The Scientific Instruments segment offers chromatography, optical spectroscopy, mass spectroscopy, dissolution testing, nuclear magnetic resonance equipment, and consumable laboratory supplies for a range of life science and chemical analysis applications.
In its Scientific Instruments unit, VARI is well positioned for life science researchers' ongoing shift to protein research and industrial companies' increasing demand for higher-technology productivity improvement tools through its push toward broadening its molecular spectroscopy franchise.
Scientific Instruments revenue was $164.7 million in 4Q09, down 30.3% y/y. In FY09, revenue was $675.4 million, down 19.5% y/y. The Zacks Digest average 4Q09 and FY09 Scientific Instruments revenue was in line with the company report.
Vacuum Technologies
The company specializes in developing vacuum systems tailored to meet the increasing consumer need. The various products offered by this segment are vacuum pumps, turbo pumping system, leak detectors, vacuum measurement, and valves and components, which are used for building mass spectrometer, medical linear accelerator, systems for producing flat panel displays, the coating of architectural glass, or high-energy physics experiments.
Vacuum Technologies revenue decreased 31.0% y/y to $31.8 million in 4Q09. In FY09, revenue was $131.4 million versus $173.8 million, down 24.4% y/y. The Zacks Digest average 4Q09 and FY09 Vacuum Technologies revenue was in line with the company report.
PRODUCT UPDATE
On November 12, 2009, VARI announced that Steady State Imaging (SSI) has signed a reseller's agreement with Varian, Inc. regarding SSI's new SWIFT Software for Varian's research MRI Systems. SWIFT is a novel MRI technology that advances existing MR techniques with the ability to silently image structures and tissues previously invisible in conventional MRI systems.
On November 5, 2009, VARI announced the release of the 325-MS triple-quadrupole LC/MS (liquid chromatograph/mass spectrometer) for the efficient detection and identification of chemical compounds in high-throughput laboratories performing environmental, food safety, and toxicology analyses.
On October 12, 2009, VARI announced a series of productivity enhancements for its 710-ES Series of ICP-OES (Inductively Coupled Plasma- Optical Emission Spectrometer) instruments. The enhancements comprise hardware, software, and accessory options available both on new instruments as well as on upgrades to existing equipment. They enable users to reduce sample analysis times by up to 50% and lower the cost of each analysis
On September 21, 2009, Varian, announced a lineup of new products to enhance the flexibility and automated use of its 400-MR Nuclear Magnetic Resonance (NMR) system. The collection of new tools comprises the OneNMR probe, a choice of two autosamplers, and an easy-to-use, customer-centric software package.
Provided below is a summary of segment revenue as compiled by Zacks Digest:
Segment Revenue ($M) / 4Q08A / 2008A / 4Q09A / 2009A / 1Q10E / 4Q10E / 2010E / 2011EScientific Instruments / $236.7 / $838.8 / $164.7 / $675.4 / $712.0 ↑
Vacuum Technologies / $45.9 / $173.7 / $31.8 / $131.4 / $138.0 ↑
Provided below is a graphical analysis of segment revenue:
Please refer to the Zacks Research Digest spreadsheet on VARI for specific estimates.
Margins
The gross margin was 43.4% in 4Q09 versus 45.5% in 4Q08. As per the Zacks Digest model, 4Q09 gross margin was 43.4% compared with 45.5% in 4Q08. In FY09, gross margin was 45.2% versus 45.7 in FY08.
Adjusted operating profit margin was 8.4% in 4Q09 versus 13.0% in 4Q08. On a GAAP basis, operating profit margin was 2.6% in 4Q09 versus 11.6% in 4Q08, due to the negative impact of lower sales volumes, product mix, and disruptions relating to the pending acquisition.
R&D expenses as a percentage of revenue were 7.0%, while, SG&A expenses as a percentage of revenue were 28.0% in 4Q09.
Scientific Instrument’s operating margin on a GAAP basis was 5.5% in 4Q09 versus 11.1% in 4Q08. In FY09, GAAP operating margin was 8.0% versus 9.6% in FY08. On an adjusted basis, Scientific Instrument’s operating margin was 10.7% in FY09 versus 11.6% in FY08. In FY09, adjusted operating margin was 8.0% versus 9.6% in FY08.
Vacuum Technologies’ operating margin on a GAAP basis was 19.5% in 4Q09 versus 19.8% in 4Q08. In FY09, GAAP operating margin was 8.0% versus 9.6% in FY08. On an adjusted basis, the operating margin was 20.1% in 4Q09 versus 19.8% in 4Q08. In FY09, adjusted operating margin was 8.0% versus 9.6% in FY08.
As per the Zacks Digest model, 4Q09 operating margin was 8.3% versus 13.1% in 4Q08. In FY09, operating margin was 10.6% versus 11.8% in FY08.
Provided below is a summary of margins as compiled by Zacks Digest:
Margins / 4Q08A / 2008A / 4Q09A / 2009A / 1Q10E / 4Q10E / 2010E / 2011E / 2012EGross / 45.5% / 45.7% / 43.4% / 45.2% / 46.8%↑
Operating / 13.1% / 11.8% / 8.3% / 10.6% / 12.1%↓
Pre-tax / 13.3% / 12.2% / 8.3% / 10.6% / 12.3%↓
Net / 8.7% / 8.0% / 5.9% / 7.2% / 8.1%↓
Outlook: As per the Zacks Digest model, COGS would decrease 19.7% y/y in FY09 and increase 2.4% y/y in FY10, SG&A expense is expected to decrease 16.1% y/y in FY09 and increase 5.3% y/y in FY10, and R&D expense is expected to decrease 21.0% y/y in FY09 and increase 5.6% y/y in FY10, thereby showing an upward trend in expenses. In comparison, revenue is expected to decrease 20.3% y/y in FY09 and increase 5.4% y/y in FY10, also showing an upward trend.
Please refer to the Zacks Research Digest spreadsheet on VARI for more extensive margin figures.
Earnings per Share
In 4Q09, Non GAAP diluted EPS was $0.40, a decrease of 48.7% from $0.78 in 4Q08. GAAP diluted EPS was $0.07 (including $0.28 of costs relating to the pending acquisition of the company by Agilent Technologies, Inc. ("Agilent"))in 4Q09 versus $0.69 in 4Q08. In FY09, Non GAAP diluted EPS was $2.01, a decrease of 23.3% from $2.62 in FY08. GAAP diluted EPS was $1.34 in FY09 versus $2.17 in FY08. As per the Zacks Digest model, 4Q09 non-GAAP EPS was in line with the company report. In FY09, EPS was $2.00 versus $2.66 in FY08.