Item 1. Business
Overview
We, Varian Medical Systems, Inc., are a Delaware corporation originally incorporated in 1948 as Varian 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. Through recent acquisitions, we now operate a hospital and a network of cancer centers in India and Sri 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, integrated cancer care solutions that leverage our strengths, technology, innovation and clinical experience. 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 of 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. The Americas region includes North America (primarily the United States and Canada) and Latin America. The EMEA region includes Europe, Russia, the Middle East, India and Africa. The APAC region primarily includes East and Southeast Asia and Australia.
Our business is subject to various risks and uncertainties. You should carefully consider the factors described in Item 1A, “Risk Factors” in conjunction with the description of our business set forth below and the other information included in this Annual Report on Form 10-K.
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 (“SRS”), stereotactic body radiotherapy (“SBRT”) and brachytherapy, as well as associated quality assurance equipment.
Our hardware products include linear accelerators, brachytherapy afterloaders, treatment accessories, artificial intelligence ("AI")-powered adaptive delivery systems and quality assurance software. 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. Our products enable radiation oncology departments in hospitals and clinics to perform conventional radiotherapy treatments and advanced treatments such as IMRT, IGRT, VMAT, SRS and SBRT, as well as the treatment of patients using brachytherapy techniques, which involve the introduction or temporary insertion of radioactive sources. Our products are also used by surgeons and radiation oncologists to perform stereotactic radiosurgery.
Our software products span the cancer care continuum, starting with pre-treatment multi-disciplinary tumor boards and cancer treatment planning, then onto the patient treatment and associated workflows, and ending with the collection of patient-reported outcomes in a post-treatment setting. Our clinical solutions software products are used primarily in radiation and medical oncology departments to manage patient treatments. Our software products help improve physician engagement and clinical knowledge-sharing, patient care management, clinical practice management and decision support. Our worldwide customers include university research and community hospitals, private and government institutions, healthcare agencies, physicians’ offices, medical oncology practices, radiotherapy centers and cancer care clinics.
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.
As a result of our acquisition of Cancer Treatment Services International ("CTSI") in June 2019, 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. Examples of these services include radiation treatment planning and quality assurance as a service. In developing markets, our offering allows us to provide a range of clinical support services that improve the use of medical technology and standardized care delivery on a per patient basis, providing increased quality and reduced costs in understaffed geographies. Our services in these markets are expected to accelerate our hardware and software businesses through broader adoption of radiation therapy and drive the provision of advanced comprehensive cancer care. In developed markets, these services can augment the existing workforce of a clinic to support staffing fluctuations and clinical quality initiatives, and can provide a bridge to new technology implementation. Further, we operate nine multi-disciplinary cancer centers and one specialty hospital in India and one multi-disciplinary cancer center in Sri Lanka. In addition to expanding our services portfolio, we expect that the CTSI acquisition will enable us 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.
Proton Solutions
Our Proton Solutions business develops, designs, manufactures, sells and services products and systems for delivering proton therapy, another form of external beam radiotherapy 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 skull, spine, optic nerve, and most pediatric cancers. Our current focus is reducing the total cost of ownership for proton therapy and bringing our expertise in traditional radiation therapy to this treatment modality, thereby improving its clinical utility and reducing its cost of treatment per patient, in order for it to be more widely accepted and deployed.
Interventional Solutions
In fiscal year 2019, we entered the interventional oncology market with our acquisitions of Endocare, Inc ("Endocare") and Alicon Pharmaceutical Technology Company. Ltd ("Alicon") in June 2019 and the acquisition of a drug-loadable embolics microspheres business from Boston Scientific in August 2019. Our Interventional Solutions business offers products for interventional oncology 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 oncology market globally through a direct salesforce and a network of distributors.
Radiation Therapy and the Cancer Care Market
Radiation Therapy
Radiation therapy is the use of certain types of focused radiation to kill cancer cells, shrink tumors, and provide palliative treatment for symptoms such as pain. Occasionally, radiation can also be used to treat non-cancerous conditions such as
arteriovenous malformations, keloids and trigeminal neuralgia. The use of radiation for treating cardiac disease is gaining interest in the medical community and is currently being investigated in a clinical trial setting. Radiation therapy is commonly used either alone or in combination with surgery, chemotherapy, immunotherapy or targeted drugs. One important advantage of radiation is that it tends to disproportionately kill cancer cells. The clinical goal in radiation oncology is to deliver a therapeutic dose directly to the tumor to kill cancerous cells while minimizing radiation exposure to surrounding healthy tissue in order to limit or avoid complications, side effects and secondary effects caused by the treatment. This goal has been the driving force in clinical care advancements in radiation oncology over the past two decades, from conventional radiotherapy to advanced forms of treatment such as IMRT, IGRT, VMAT, SRS, SBRT, AI-powered adaptive radiation therapy ("ART"), brachytherapy and proton therapy.
The most common form of radiation oncology involves delivering X-ray beams from outside of the patient’s body, a process sometimes referred to as external beam radiotherapy. A device called a medical linear accelerator generates the high-energy X-ray beams and delivers the radiation to the patient lying on a treatment couch. The linear accelerator rotates around a patient by delivering a radiation beam that is conformed to the tumor shape from different angles. This concentrates radiation at the tumor while at the same time minimizing the dose delivered to the surrounding healthy tissue. Conventional radiotherapy typically involves multiple, or fractionated, treatments of a tumor in up to 50 treatment sessions. The linear accelerator may also deliver electron beams for the treatment of diseases closer to the body surface.
IMRT is an advanced form of external beam radiotherapy in which the shape and intensity of the radiation beams are varied optimally (modulated) across the target region. IMRT allows the radiation dose to be more precisely conformed to the volume of the tumor, allowing physicians to deliver higher doses of radiation to the tumor than conventional radiation treatments, while limiting the radiation dose to nearby healthy tissue. In this way, clinicians can design and administer an individualized treatment plan for each patient, targeting the tumor within millimeters. IMRT can be used to treat head and neck, breast, prostate, pancreatic, lung, liver, gynecological and central nervous system cancers. IMRT has become a well-accepted standard of treatment for cancer, and every year additional treatment centers, from university hospitals to local community clinics, adopt IMRT for their treatments. We are a leading global provider of products that enable IMRT for the treatment of cancer.
VMAT is a significant further advancement in IMRT that allows physicians to control three parameters simultaneously: (i) the rate at which the linear accelerator gantry rotates around the patient, (ii) the beam-shaping aperture and (iii) the rate at which the radiation dose is delivered to the patient. This creates a finely-shaped IMRT dose distribution that more closely matches the size and shape of the tumor, with faster treatment times. Our RapidArc® radiotherapy products plan and deliver VMAT treatments.
Physicians, hospitals and clinics place additional value on radiotherapy equipment and treatments, such as VMAT, that enable shorter treatment times, increased quality of dose distributions and greater patient throughput. From the patient’s standpoint, reduced treatment times means that the patient is immobilized on the treatment couch for a shorter time period. Shorter treatment sessions decrease waiting times and, since treatments are delivered in fractions over the course of many days, can mean fewer disruptions to a patient’s daily routine. From the physicians’ and hospitals’ standpoint, shorter treatment times can lessen the chance of tumors moving during treatment and can increase patient throughput. Shorter treatment times and increased patient throughput can increase the number of treatments per day (which is a particular concern in countries with lower numbers of treatment machines per capita) and, as a result, can decrease the cost per treatment and allow greater access to advanced care for more patients.
IGRT is another advanced form of external beam radiotherapy complementing IMRT, VMAT, SRS, and SBRT to enhance treatments. While IMRT helps physicians more precisely conform the beam to the tumor, IGRT allows physicians to see how a tumor and normal tissue move or change during a course of treatment, thereby improving treatment accuracy. This allows clinicians to tighten the margin of certainty around the tumor and spare more of the surrounding healthy tissue, potentially improving outcomes. We believe IGRT has become an accepted standard for treatment in the radiation oncology community. Varian's latest state-of-the-art linear accelerator mandates that all fractions of radiation delivered have IGRT before the treatment is delivered.
SRS and SBRT, often collectively referred to as radiosurgery, are advanced ablative radiation treatment procedures performed in a small number of treatment sessions with high doses of radiation. Radiosurgery typically incorporates advanced image-guidance to focus many small beams of radiation from many orientations precisely on the target and to minimize the dose to surrounding normal tissues. Radiation oncologists, surgeons and other oncology specialists increasingly recognize radiosurgery as a useful tool to treat cancerous and non-cancerous lesions anywhere in the body.
Adaptive radiation therapy is a clinical treatment approach that takes a patient’s treatment plan and adapts it to a patient’s
changing tumor volume and anatomy during the course of therapy. IMRT, VMAT, SRS, and SBRT all shape the radiation dose with increased levels of fidelity, and IGRT allows an image to be taken to verify how the patient should be re-positioned for the original treatment plan to be applied for therapy delivery. Adaptive radiation therapy re-creates the treatment plan based on changes in location of a tumor or surrounding anatomy during the course of therapy. These changes can manifest from tumor response, weight loss or anatomical deformation of internal structures. There are two types of adaptive radiation therapy - offline and online. In offline adaptive radiation therapy, adaptation of the treatment plan takes place between treatment visits and in online adaptive radiation therapy, adaptation takes place while the patient is on the treatment couch for each treatment.
An alternative to external beam radiotherapy, brachytherapy involves the insertion of radioactive seeds, wires or ribbons directly into a tumor or body cavity near the tumor. These techniques tend to irradiate much less surrounding healthy tissue so that physicians can prescribe a higher total dose of radiation, typically over a shorter period of time. Brachytherapy is often used for cancers of the head and neck, breast, uterus, cervix, soft tissue, skin and prostate.
Proton therapy is another form of external beam radiotherapy that uses proton particles generated with a cyclotron rather than X-ray beams from a linear accelerator. A proton beam’s signature energy distribution curve, known as the “Bragg peak,” allows for greater precision in targeting tumor cells with an even lower dose to nearby healthy tissue than may be delivered with X-ray beams from a linear accelerator. This makes proton therapy a preferred option for treating certain cancers, particularly cancers in children and tumors near critical structures such as the spine. Pencil-beam scanning capability, which is an advanced way of delivering the proton beam, allows for greater sparing of healthy tissue compared to scattering and collimation of the proton beam. Pencil beam scanning treatments are often referred to as Intensity Modulated Proton Therapy ("IMPT").
With the advent of radiosurgery and stereotactic body radiotherapy, other mechanisms of killing cancer cells are also being explored, including immunotherapy technologies, which involve using radiation to stimulate the immune response to fight cancer growth.
Radiation Oncology Market
The radiation oncology market is growing globally due to a number of factors. According to the World Health Organization Global Cancer Observatory, there were approximately 18 million cancer cases diagnosed worldwide in 2018, and the number of new cancer cases diagnosed annually is projected to increase to almost 25 million by 2030. According to the September 2015 Lancet Oncology report compiled by the Global Task Force on Radiotherapy for Cancer Control, most of the increase is coming from low- and middle-income countries such as China and India. In addition, technological advancements have helped to improve the precision and applicability of radiotherapy and radiosurgery, potentially expanding the use of radiotherapy and radiosurgery equipment to treat a broader range of cases. Technological advances in hardware and software are also creating a market for replacing an aging installed base of machines that are unable to deliver new, higher standards of care.
The rise in cancer cases, together with the increase in sophistication of new treatment protocols, have created a demand for more automated products and services that can be integrated into clinically practical systems to make treatments more rapid and cost effective. Technology advances leading to improvements in patient care, the availability of more advanced, automated and efficient clinical tools in radiation therapy, the advent of more precise forms of radiotherapy treatment (such as IMRT, IGRT, VMAT, SRS, SBRT, brachytherapy and proton therapy), and innovative new technology and equipment (such as the Halcyon™, Ethos™, EDGE® and TrueBeam® systems) that enable treatments that reduce treatment times and increase patient throughput should drive the demand for our radiation therapy products and services.
International markets, in particular, are under-equipped to address the growing cancer incidence. Patients in many foreign countries must frequently endure long waits for radiotherapy. According to a peer-reviewed publication in the International Journal of Radiation Oncology Biology and Physics in 2014, radiotherapy is required in more than half of new cancer patients, particularly in low- and middle-income countries, and according to an article published in Seminars in Radiation Oncology in 2017, it is estimated that more than 12,000 additional treatment machines will be required by 2035 in these countries alone. For example, China, India and Brazil are estimated to require over 3,800, 1,200 and 400 additional machines, respectively, by 2035. The 12,000 linear accelerators necessary to meet the global demand for cancer care will require an estimated 150,000 trained clinicians to operate the machines. It is unlikely that existing clinical training programs will be able to train 150,000 new clinicians by 2035; therefore, we anticipate an increase in demand for Varian’s technology enabled services offered by CTSI.
The ever-increasing incidences of cancer and the demand for additional treatment machines in these regions represent additional drivers for our continued growth in international markets.
Interventional Oncology Market
Interventional oncology is a field of interventional radiology that deals with the diagnosis and treatment of cancer using targeted minimally invasive procedures performed under image guidance. The interventional oncology market includes several categories of treatment modalities: ablation devices (cryoablation, microwave ablation and radiofrequency ablation), embolization devices (bland microspheres or particles, drug-loadable microspheres and radioembolic agents), and other support devices such as catheters and guidewires. In terms of cancer types, the interventional oncology market primarily includes treatment of liver, lung, kidney, breast, bone, and prostate.
We operate in some of the fastest-growing geographies with an accelerating burden of cancer. These markets generally are economically challenged to provide broad access to care for cancer patients. Given the low cost of ownership for our Interventional Solutions portfolio, these markets are significant opportunities to expand our global footprint with cost effective cancer fighting solutions. Our Interventional Solutions business intends to increase its market share through commercial expansion, additional regulatory clearances in new markets, and continued innovation in its product offerings. We believe that interventional oncology is quickly growing into the fourth pillar of cancer care worldwide, along with radiation oncology, surgical oncology and medical oncology.
According to a market analysis conducted by an independent market analyst, the global interventional oncology market is expected to be approximately $1.1 billion by 2022, within the overall interventional radiology market. The primary users of ablation and embolization products are interventional radiologists and oncologists for the treatment of various cancer lesions. An increase in the elderly population, a rising cancer risk due to unhealthy habits and pollution, increased early detection, awareness and knowledge of cancer treatments, and rise in disposable income are factors fueling the growth of these products at an annual growth rate of 7%.
Products
Oncology Systems
Our Oncology Systems business is the leading provider of advanced hardware and software products for the treatment of cancer with conventional radiation therapy, and advanced treatments such as IMRT, IGRT, VMAT, SRS, SBRT and brachytherapy. Oncology Systems products address each major aspect of the radiotherapy process, including linear accelerators and accessory products for positioning the patient and delivering the X-ray beam; brachytherapy afterloaders for delivering radioactive implantable seeds; treatment planning software for planning treatment sessions and dose delivery; treatment accessories and quality assurance software for simulating and verifying treatment plans before treatment as well as verification of correct treatment delivery; and information management software for recording the history and results of treatments and other patient treatment information and data, including patient images.
The focus of our Oncology Systems business is addressing the key concerns of the market for advanced cancer care systems; improving efficiency, precision, cost-effectiveness and ease of delivery of these treatments; and providing greater access to advanced treatments. A core element of our business strategy is to provide our customers with highly versatile, proven products that are interoperable and can be configured and integrated into automated systems that combine greater precision, shorter treatment times and greater cost effectiveness to improve the entire process of treating a patient. Our products and accessories for IMRT and IGRT allow clinicians to track and treat tumors using very precisely shaped beams, targeting the tumor as closely as currently possible and allowing the delivery of higher doses of radiation to the tumor while limiting exposure of nearby healthy tissue. Additionally, the precision and versatility of our products and technology make it possible to use radiotherapy to treat metastatic cancers. With our treatment planning, verification and information management software products, a patient’s treatment plans, treatment data and images are recorded and stored in a single database shared by each of our products, which enables better communication among products. Our products also allow multiple medical specialties such as, radiation oncology, neurosurgery, diagnostic radiology and medical oncology, as well as allowing clinicians in multiple locations to share equipment, resources and information in a more efficient, cost-effective manner. Furthermore, the ability of our products and technology to interoperate with each other and to interconnect into automated systems allows physicians to schedule and treat more patients within a set time period, which adds to the cost-effectiveness of our equipment.
Hardware Products
Medical linear accelerators are the core device for delivering conventional external beam radiotherapy and advanced treatments such as IMRT, IGRT, VMAT, SRS, SBRT, and ART, and we produce versions of these devices to suit various clinical requirements. The TrueBeam and EDGE systems for image-guided radiotherapy and radiosurgery are fully-integrated high-energy linear accelerator systems designed from the ground up to treat a moving target with higher speed and accuracy. The Clinac® iX linear accelerators deliver high-energy X-ray beams and are designed for more streamlined and advanced treatment
processes, including IMRT and IGRT. We also produce the Trilogy® linear accelerator, designed to be a versatile, cost-effective, precise high-energy device with a faster dose delivery rate and more precise isocenter compared to the Clinac iX. Our UNIQUE™ medical linear accelerator is a low-energy linear accelerator for the more price sensitive emerging markets, designed to meet the evolving needs of our IMRT and IGRT customers in these markets.
In September 2019, we introduced our Ethos™ therapy, an AI-Powered Adaptive Radiotherapy Treatment system. We received a CE Mark for Europe in August 2019 and are currently awaiting FDA 510(k) clearance in the United States. The first patient was treated on this system at Herlev Hospital, University of Copenhagen in September 2019. Ethos therapy is an AI-driven holistic solution that includes a linear accelerator and is designed to increase the capability, flexibility and efficiency of radiotherapy. This new solution is designed to deliver an entire online adaptive treatment in a typical 15-minute time slot, from patient setup through treatment delivery. Adaptive therapy provides the ability to alter the treatment plan based on tumor and anatomical changes. The goal is to better target the tumor, reduce the dose to healthy tissue and potentially improve overall outcomes.
In May 2017, we introduced our Halcyon™ treatment system. We received a CE mark for the Halcyon system in May 2017 and FDA 510(k) clearance in June 2017. The Halcyon system has been designed on a platform of next generation technology including a full field ring gantry design that rotates at four times per minute, an innovative stacked and staggered multi-leaf collimator design, virtually silent magnetic drive motors and solid-state modulators. This new platform is the smallest footprint linear accelerator in our portfolio, uses less energy than our other radiation therapy treatment systems, and has been designed with a human centered user experience concept that benefits the patient and the health care practitioner for simplicity of treatment and use.
Our Millennium™ series of multi-leaf collimators and High Definition 120 (“HD 120”) multi-leaf collimators are used with a linear accelerator to define the size, shape and intensity of the generated beams. PortalVision™, our electronic portal-imager, is used to verify a patient’s position while on the treatment couch, which is critical for accurate treatments and simplifies quality assurance of individual treatment plans. We also offer an innovative real-time patient position monitoring product, the Real-Time Patient Management™ ("RPM") respiratory gating system, which allows the linear accelerator to be synchronized with patient breathing to help compensate for tumor motion during treatment. In addition, we manufacture the Calypso® system (some features not approved for use in all markets), which can continuously track and monitor the position of implanted or surface-attached Beacon® transponders. This technology allows the clinician to easily locate the position of the tumor and aim the treatment beam precisely to deliver the full, prescribed dose to the tumor, and minimize exposure of surrounding healthy tissues.
Our EDGE radiosurgery suite is comprised of a combination of products for performing advanced radiosurgery using new real-time tumor tracking technology and motion management capabilities. The EDGE radiosurgery suite includes the EDGE radiosurgery accelerator, the Calypso system with Dynamic Edge™ Gating, and the PerfectPitch™ couch with six degrees of freedom to accurately and precisely align the patient position. Our IGRT accessories include the On-Board Imager® (“OBI”) hardware accessory affixed to the linear accelerator that allows dynamic, real-time imaging of tumors while the patient is on the treatment couch and offers cone-beam computerized tomography (“CBCT”) imaging software capability to allow patient positioning based on soft-tissue anatomy. Using sophisticated image analysis tools, the CBCT scan can be compared with a reference computerized tomography scan to determine how the treatment couch should be adjusted to fine-tune and verify the patient’s treatment setup and positioning prior to delivery of the radiation. To deliver the most advanced forms of IGRT, our accelerators would typically have an OBI, CBCT, PortalVision and other IGRT-related hardware and software as accessories.
Our RapidArc radiotherapy products are a proprietary implementation of VMAT that coordinate beam shaping, dose rate and gantry speed to deliver a highly conformal dose distribution to the target tumor. RapidArc products enable the planning and delivery of image-guided IMRT in a single continuous rotation of up to 360 degrees rather than as a series of fixed fields. Our RapidArc products enable faster delivery of radiation treatment with the possibility of reduced opportunity for tumor movement during treatment, as well as greater patient throughput and lower cost per patient for the hospital or clinic. We believe RapidArc represents a significant advancement in IMRT cancer treatment.
Our HyperArcTM high-definition radiotherapy product is designed to simplify, automate and improve the quality of intracranial SRS, making SRS accessible to more clinics and patients around the world. HyperArc received a CE mark in August 2017 and FDA 510(k) clearance in September 2017 and is currently available for sale in the United States and other global markets where a CE mark is applicable. We expect that HyperArc will significantly improve the quality and efficiency of sophisticated SRS procedures. HyperArc is available only on the TrueBeam and Edge platforms.
We purchased Mobius Medical Systems ("Mobius") in February 2018. Mobius markets and sells quality assurance products to radiation oncology departments around the globe. We will continue to sell those products while expanding and integrating the
technology for current and future applications. In July 2018, we acquired humediQ GmbH, which markets and sells the IDENTIFY ™ products that enable patient and accessory verification, patient setup position, and motion monitoring for radiation oncology treatments. We will continue to market and sell these products as we expand the regulatory clearance footprint around the globe and enhance and integrate the technology for current and future applications.
Brachytherapy products
Our brachytherapy operations design, manufacture, sell and service advanced brachytherapy products, including VariSource™ HDR and GammaMedplus™ iX HDR/PDR afterloaders, BrachyVision™ brachytherapy treatment planning system, applicators and accessories. We also develop and market the VariSeed™ LDR prostate treatment planning system and the Vitesse™ software for real-time treatment planning for HDR prostate brachytherapy.
Our Bravos™, brachytherapy treatment delivery system, is now available in over 100 countries where CE Mark and 510(k) clearance are applicable. Bravos is an integrated system designed to improve the patient and clinic experience by simplifying brachytherapy treatment and providing greater workflow efficiency. It is compatible with our full range of applicators and integrates with BrachyVision for treatment planning. BrachyVision fully integrates with the ARIA oncology information system that coordinates care from end to end, scheduling appointments, orchestrating the clinical workflow, delivering the plan to the afterloader, updating the patient's electronic record, and capturing clinical data for analytics.
Software Products
Our software products enhance and enable the delivery of advanced radiotherapy treatments, from the initial treatment planning and plan quality assurance verification to the post-treatment recording of data and storing of patient information, as well as help improve physician engagement and clinical knowledge-sharing, patient care management and clinical practice management of cancer clinics, radiotherapy centers and oncology practices for better performance. Prior to any treatment, physicians must prescribe, or plan, the course of radiation delivery for the patient. We offer a range of treatment planning products that assist physicians in designing this treatment plan. Our Eclipse™ treatment planning system provides physicians with 3D image viewing, treatment simulation, radiation dosage calculation and verification and other tools for generating treatment delivery plans for the patient. The Eclipse software utilizes a sophisticated technique known as inverse planning to enable physicians to rapidly develop optimal treatment plans based on a desired radiation dose outcome to the tumor and surrounding tissue. Our RapidPlan® knowledge-based planning tool creates a new category for artificial intelligence applied to treatment planning systems in which machine learned statistical models can be used to predict the achievable quality of an IMRT treatment from a patient’s anatomy. RapidPlan is designed to streamline the planning process by using shared clinical knowledge embedded in its statistical plan models. Clinics may use plan models included with Eclipse or can create models based on their own treatment methods and protocols.
We continue to enhance our treatment planning software products and have integrated multi-criteria optimization radiotherapy treatment planning algorithms licensed from the Fraunhofer Institute that enable clinicians to quickly navigate solution space to find the ideal treatment plan for each patient. We have incorporated this technology along with other treatment planning software tools to enhance both treatment planning efficiency and quality.
Our ARIA® information system is a comprehensive oncology information system spanning radiation therapy and chemotherapy treatments and departmental workflow management. ARIA offers a real-time information management system and database that records and verifies radiotherapy treatments carried out on the linear accelerator, records and stores patient data relating to radiation therapy, provides oncology flowsheets, performs patient charting and manages patient information and patient image data. This gives clinics and hospitals the ability to manage treatment and patient information across radiation oncology and medical oncology procedures. Also, because ARIA is an electronic medical record, it can enable users to operate filmless and paperless oncology departments and cancer clinics. ARIA is a (ONC-Health IT) 2015 Edition Health IT Module and supports the ICD-10 billing codes. Our FullScale™ oncology-specific information technology solutions take advantage of virtualization or cloud technologies to deploy our ARIA oncology information and Eclipse treatment planning systems in a way that enables treatment centers to take advantage of economies of scale. We have from time to time entered into agreements with a variety of companies to increase the capabilities of our ARIA information systems software. Our software product offerings also include Varian Treatment™, which connects ARIA® oncology information management system (“ARIA”) to third-party linear accelerators and expands our software support of third-party manufacturers.
Our Insightive™ analytics software solution aggregates clinical and operational data and allows for improved decision making and practice management. Insightive enables oncology administrators and clinicians to use real-time information to discover patterns and trends through interactive dashboards and visualizations. We also created an interactive online group on the
OncoPeer™ platform for clinicians to share knowledge-based cancer treatment models that can improve the efficiency and quality of cancer care across multiple institutions. The OncoPeer cloud community is a platform where oncologists, clinicians and other oncology professionals can publish knowledge, share data, exchange treatment techniques and discuss best practices within a professional oncology network.
Our Velocity™ software provides solutions at the clinical process level to aggregate unstructured treatment and imaging data from diverse systems. It allows for a more comprehensive view of a patient’s diagnostic imaging and treatment history and helps clinicians make more informed treatment decisions.
360 Oncology® is a care management platform designed to integrate and coordinate key elements of cancer care, so patients and their cancer teams can collaborate on achieving the best outcomes. In a single platform, 360 Oncology brings together radiation, medical and surgical oncology, social services, primary care physicians, as well as the patient, to facilitate true collaborative and coordinated care. It enables tumor boards to more effectively coordinate patient care among the numerous specialists involved in cancer treatment. With Varian 360 Oncology care management, a clinic’s data, records and patient information are connected through a single platform, enabling the entire cancer-fighting team to coordinate care.
Qumulate™ is our cloud-based software technology that collects and analyzes machine performance data in a radiation therapy department and allows users to compare their machine performance data and trends against a community of users’ data.
Our Noona® software application is a smart, cloud-based patient-reported outcomes solution. Through the capture and analysis of structured, real-time symptom information, Noona helps clinicians better manage patient symptoms and improve treatment outcomes. Noona is designed to support the everyday work of nurses and physicians in cancer care, helping to increase clinical efficiency and reduce workloads through comprehensive communications tools.
Partnerships
In addition to offering our own suite of equipment and software products for planning and delivering radiotherapy treatments, we have partnered with selected leaders in certain segments of the radiation therapy and radiosurgery market. We have a strategic agreement with McKesson Corp. ("McKesson") to supply its US Oncology Network and Vantage Oncology affiliated sites of care with treatment delivery systems and planning, service and radiotherapy information system solutions. Under the agreement, we are collaborating with McKesson to establish interoperability between our ARIA product and McKesson IT solutions which we anticipate will facilitate access to our ARIA, Eclipse and Velocity products at its sites that do not currently utilize these solutions. We have a partnership agreement with Siemens AG (“Siemens”) through which, among other things, we represent Siemens diagnostic imaging products to radiation oncology clinics in the United States and agreed upon countries, and Siemens, represents our equipment and software products for radiotherapy and radiosurgery to its healthcare customers in agreed upon countries. Furthermore, we and Siemens have developed interfaces to enable ARIA and Eclipse to connect with Siemens linear accelerators and imaging systems, and are exploring opportunities to co-develop new imaging and treatment solutions. We have equity investments which include Grail, Inc., a life sciences company developing blood tests for early-stage cancer detection and Fusion Pharmaceuticals Inc., a clinical stage company focused on developing targeted alpha-particle radiotherapeutics for the treatment of cancer.
CTSI
CTSI oncology solutions facilitates the use of clinical processes and technology solutions that ensure the delivery of precise, consistent and safe care to cancer patients worldwide. CTSI offers services ranging from treatment planning as a service, quality assurance as a service, linear accelerator commissioning, practice workflow optimization, oncology nursing training, clinical decision support, international tumor board and other multi-disciplinary services to improve care delivery. The range of services focus on participating in the clinical workflow to support the decisions of clinicians rather than the direct provision of care. CTSI services also include a full-service laboratory and pathology provider, and under our American Oncology Institute ("AOI") brand, we operate nine multi-disciplinary cancer centers and one specialty hospital in India and one multi-disciplinary cancer center in Sri Lanka.
Proton Solutions
Our ProBeam® system is capable of delivering precise intensity modulated proton therapy (“IMPT”) using pencil-beam scanning technology. The ProBeam® Compact product is our lower cost, single room proton therapy product launched in fiscal year 2014. During fiscal year 2016, we booked our first ProBeam Compact order. In October 2018, we introduced our new ProBeam® 360°proton therapy product, in a single-room configuration, with a 30 percent smaller footprint and 25 percent
lower vault construction costs as compared to the ProBeam Compact. The new system has a 360-degree rotating gantry, iterative cone-beam CT imaging and high-definition pencil-beam scanning technology. The system can also provide a viable path to potential next generation treatments. In September 2019, we introduced the multi-room version of ProBeam 360°, which provides comparable space and cost savings as the single room version.
Due to the intrinsic physical properties of proton therapy, it 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 high capital cost. Proton therapy facilities are large-scale construction projects that are time consuming, involve significant customer investment and often complex project financing. Consequently, this business is vulnerable to general economic and market conditions, as well as country specific coverage and reimbursement rates. Customer decision-making cycles tend to be very long, and orders generally involve many contingencies. Credit markets for proton therapy projects have improved in recent years but the funding environment for large capital projects, such as proton therapy projects, is still challenging.
At the end of fiscal year 2019, our proton therapy systems are in operation at eleven centers, which have a total of 41 operational rooms. During fiscal years 2019, 2018 and 2017, we recorded four, two and six proton therapy system orders, respectively.
In limited cases, we participate, along with other investors and at market terms, in the financing of proton therapy centers. See Note 15, "Proton Solutions Loans and Investment," of the Notes to the Consolidated Financial Statements for further discussion on our Proton Solutions financing arrangements.
Interventional Solutions
Our Interventional Solutions business offers products for interventional oncology procedures and treatments, including cryoablation, microwave ablation and embolic particles. We also provide software and remote services for post treatment dose calculation for Yttrium-90 microspheres, radioactive beads used in selective internal radiation therapy.
Ablation Products
Our CRYOCARE® ablation systems, acquired as part of the Endocare acquisition, are fully integrated planning, placement and treatment systems designed to simplify cryotherapy and to meet physician needs. Our ablation systems are used by customers primarily to treat liver, lung, kidney and prostate cancer. Our CRYOCARE CS ablation systems use argon and helium, which eliminates some of the issues associated with liquid nitrogen systems.
Our microwave ablation device, also acquired through the Endocare acquisition, features the MICROTHERMX® ("MTX") generator and the specifically designed Synchronous Wave Alignment® technology antennas. The generator is a low-profile device with a small footprint which can be set up in less than two minutes. The generator uses a 915 MHz operating frequency and can power up to 180W (60W per channel/antenna) for optimized power delivery. The SynchroWave® antennas are designed to work in synchrony with one another to create large active heating and ablation volumes.
Embolization Therapy Products
Our Gelatin Sponge Particle and Polyvinyl Alcohol ("PVA") Particle products, acquired as part of the Alicon acquisition, comprise a range of calibrated particles used primarily for the treatment of liver cancers. Currently, these products are only offered outside of the United States. The Gelatin Sponge particles are degradable (resorbable), while the PVA particles are for permanent occlusion within a blood vessel.
Included in the drug-loadable embolics microspheres business acquired from Boston Scientific were Embozene®, Oncozene® and Tandem® microsphere products. The Tandem microsphere product is only offered outside of the United States. Embozene and Oncozene microspheres are intended for embolization of arteriovenous malformations and hypervascular tumors, including uterine fibroids and hepatoma, and for embolization of prostatic arteries for symptomatic benign prostatic hyperplasia. These products are available in a broad range of tightly calibrated sizes for greater embolization control.
Marketing and Sales
We employ a combination of a direct sales force and independent distributors or resellers for the marketing and sales of our products worldwide. Our gross orders and revenues reflect a growing percentage from international regions and particularly
emerging markets. As a U.S.-based company, the competitiveness of our product pricing is influenced by the fluctuation of the U.S. Dollar against other currencies. A stronger U.S. Dollar against foreign currencies would make our product pricing more expensive and less competitive compared to products sold in non-U.S. Dollar currencies. A stronger U.S. Dollar against foreign currencies would also lower our international revenues and gross orders when measured in U.S. Dollars. In fiscal years 2019, 2018 and 2017, we did not have a single customer that represented 10% or more of our total revenues.
Oncology Systems
Our Oncology Systems business sells direct in the United States and Canada and uses a combination of direct sales and independent distributors in international regions.
We sell our Oncology Systems products primarily to university research and community hospitals, private and governmental institutions, healthcare agencies, physicians’ offices and cancer care clinics worldwide. These hospitals, institutes, agencies, physicians’ offices and clinics replace equipment and upgrade treatment capability as technology evolves. Sales cycles for many of our external beam radiotherapy products are typically quite lengthy because they are affected by capital equipment budgeting cycles. Our customers frequently fix capital budgets one or more years in advance. Through our strategic global partnership with Siemens, we represent Siemens diagnostic imaging products to radiation oncology clinics in the United States and some other small, select markets. Siemens represents our equipment and software products for radiotherapy and radiosurgery to its healthcare customers in agreed upon countries.
Approximately half of Oncology Systems gross orders and revenues come from international markets, within which certain emerging markets typically 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 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.
The radiation oncology market in North America is largely characterized by replacements of older machines, with periodic increases in demand driven by the introduction of new technologies. Reimbursement rates in the 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 in the United States could be impacted as customers’ decision-making processes are complicated by the uncertainties surrounding reimbursement rates and models for radiotherapy and radiosurgery, such as the alternative payment model ("APM") pilot program for radiation oncology that was proposed by the Centers for Medicare and Medicaid Services ("CMS") in July 2019. This pilot program 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.
Proton Solutions
Our Proton Solutions business primarily uses direct sales specialists who collaborate with our Oncology Systems sales group globally on customer projects. Potential customers are government-sponsored hospitals, research institutions and research universities, which typically purchase products through public tenders, as well as private hospitals, clinics and private developers. While this market is still developing and has been highly variable over the last several years, we believe that this market has the potential to grow over the longer term mostly driven by institutions that wish to expand their clinical offerings and increase their profile in their respective communities. We will continue to invest resources to grow this business. Proton therapy facilities are large-scale construction projects that are time consuming 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. Credit markets for proton therapy projects have improved in recent years but the funding environment for large capital projects, such as proton therapy projects, is still challenging.
Interventional Solutions
We sell our Interventional Solutions line of products in the United States primarily through a direct sales force and internationally through a combination of direct sales and distributors. We support our customers with customer service representatives, sales representatives, clinical specialists and market development managers. We focus our sales and marketing efforts on interventional radiologists, interventional oncologists and urologists.
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 recognized from backlog at current exchange rates, with any difference recorded as a backlog adjustment. Orders may be revised as customers’ needs change and as our new products become available; consequently, it is difficult to predict with certainty the amount and timing of when backlog will result in revenues. Our backlog at the end of fiscal year 2019 was $3.4 billion, of which we expect to recognize approximately 40% to 46% as revenues in fiscal year 2020. Our backlog at the end of fiscal year 2018, was $3.2 billion, of which approximately $1.2 billion was recognized as revenues in fiscal year 2019. Our Oncology Systems backlog represented 93% of the total backlog at the end of both fiscal year 2019 and 2018.
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 the revenues are 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 be converted to revenue, we record a backlog adjustment which reduces backlog but does not impact gross orders for the period.
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. In fiscal years 2019, 2018 and 2017, our backlog adjustments were a net reduction of $136.6 million, $152.8 million and $154.5 million, respectively.
Competition
The markets for cancer treatment and services are characterized by rapidly evolving technology, intense competition and pricing pressure. We compete with companies worldwide, some of whom may have greater financial, marketing and other resources. Large amounts of resources are being invested in the research and development of new therapies for cancer. The successful development of alternative therapies for cancer, for example, immunotherapy, increased efficacy of new therapies or existing products, pricing decisions by competitors and the rate of market penetration by competitive products may render our products obsolete or noncompetitive.
Our smaller competitors could be acquired by companies with greater financial strength, which could enable them to compete more aggressively. Some of our suppliers or distributors could also be acquired by competitors, which could disrupt these supply or distribution arrangements and result in less predictable and reduced revenues. New competitors and new technologies, such as radiosurgery, VMAT, MR-Linac and proton therapy, will compete directly with our products or will compete for customer budget allocation. We have directed substantial product development efforts into (i) increasing the interconnectivity of our products for more seamless operation within a system, (ii) enhancing the ease of use of our software products and (iii) reducing setup and treatment times and increasing patient throughput. We have also maintained an “open systems” approach that allows customers to “mix and match” our various individual products, incorporate products from other manufacturers, share information with other systems or products and use the equipment for offering various methods of radiation therapy treatment. We have done this based on our belief that such interconnectivity will increase the acceptance and adoption of IMRT, IGRT and VMAT and will stimulate demand for our products. There are competitive “closed-ended” dedicated-use systems, however, that place simplicity of use ahead of flexibility. If we have misjudged the importance to our customers of maintaining an “open systems” approach, or if we are unsuccessful in our efforts to sustain interconnectivity, enhance ease-of-use and reduce setup and treatment times, our revenues could suffer.
Our Oncology Systems customers’ equipment purchase considerations typically include: reliability, servicing, patient throughput, precision, price, payment terms, connectivity, clinical features, the ability to track patient referral patterns, long-term relationship and capabilities of customers’ existing equipment. We believe we compete favorably with our competitors based upon our strategy of providing a complete package solution of products and services in the field of radiation oncology and our continued commitment to global distribution and customer services, value-added manufacturing, technological leadership and new product innovation. To compete successfully, we must provide technically superior, clinically proven products that deliver more precise, cost effective, high quality clinical outcomes, together in a complete package of products and services, and do so ahead of our competitors. Since our Oncology Systems products are generally sold on a basis of total
value to the customer, our business may suffer when purchase decisions are based solely upon price, which can happen if hospitals and clinics give purchasing decision authority to group purchasing organizations. Further, competitors may delay customer purchasing decisions as customers evaluate competitive product offerings, potentially extending our sales cycle and adversely affecting our gross orders.
We are the leading provider of medical linear accelerators and related accessories. In the radiotherapy and radiosurgery markets, we compete primarily with Elekta AB and Accuray Incorporated. Additionally, Elekta AB and ViewRay Incorporated have introduced MR-Linac devices that also compete with us for hospital budget allocations. Sun Nuclear Corporation and Standard Imaging have QA products that compete with our Mobius and Qumulate offerings. Vision RT, Brainlab and C-RAD have products that compete with our humediQ product line in the areas of patient monitoring and tracking during therapy. With our information and image management, simulation, treatment planning and radiosurgery products, we also compete with a number of other companies, such as Philips Medical Systems, RaySearch Laboratories AB, Brainlab AG and Best Theratronics, Ltd. We also encounter some competition from providers of enterprise hospital information systems. With respect to our brachytherapy solutions, our competitors are Elekta AB, MIM Software Inc. and Eckert & Ziegler BEBIG GmbH. In our Oncology Systems service and maintenance business, we compete with independent service organizations and our customers’ internal service organizations.
In addition, as a radiotherapy and radiosurgery equipment provider, we also face competition from other cancer treatment alternatives, such as traditional surgery, chemotherapy, robotic surgery and drug therapies, among others. To compete successfully, we need to demonstrate and convince our customers and cancer patients of the advantages of radiation therapy over or in addition to other cancer treatment alternatives. This may involve funding and, in some instances, sponsoring clinical research and studies relating to the efficacy, comparative effectiveness and safety of radiation therapy as compared to such other alternative treatments.
Our ARIA and 360 Oncology software competes with Elekta AB and large electronic medical record companies such as EPIC and CERNER, as well as multiple new competing products from established companies such as Roche (Navify and Flatiron), Philips etc., and emerging competitors such as Carevive Systems Inc, and Syapse, Inc.
The proton therapy market is still developing and is characterized by rapidly evolving technology, high competition and pricing pressure. Our ability to compete successfully depends, in part, on our ability to lower our product costs, and develop and provide technically superior, clinically proven products that deliver more precise, cost-effective, high quality clinical outcomes, including integration of IGRT technologies such as integrated volumetric imaging. In the proton therapy market, we compete principally with Hitachi Heavy Industries, Ion Beam Applications S.A., and Mevion Medical Systems, Inc. There are a number of smaller competitors that are also developing proton therapy products. We are the only established company in the field of radiation therapy to enter the proton therapy market directly.
The interventional oncology market is highly competitive. We face significant competition from large to small competitors across our product lines and in each geographic region where our products are sold. Our primary competitors include: Boston Scientific Corporation; Cook Medical LLC; Medtronic plc; Merit Medical Systems, Inc.; Terumo Medical Corporation; AngioDynamics, Inc.; MedWaves, Inc.; and Johnson & Johnson. Our main competitive strengths are product innovation, having a broad line of quality products and expertise in the field of radiation oncology.
Customer Services and Support
We warrant most of our Oncology Systems products for parts and labor for 12 months, and we offer a variety of post-warranty equipment service contracts and software support contracts to suit customers’ requirements. We have 28 service centers located in North America, EMEA and APAC.
We also have field service personnel throughout the world for Oncology Systems customer support services. Key Oncology Systems education operations are located in Beijing, China; Cham, Switzerland; Las Vegas, Nevada; Mumbai, India; Tokyo, Japan; and Montreal, Canada. Our network of service engineers and customer support specialists provide installation, warranty, repair, training and support services, project management, site planning, and professional services. We also have a distributed service parts network of regional hubs and forward-stocking locations across all major geographic areas. We generate service revenues by providing our customers with time-and-materials services, replacement part sales, post-warranty equipment service contracts and software support contracts. Most of the field service engineers are our employees, but our products are serviced by employees of distributors and/or agents in a few foreign countries. Customers can access our extensive service network by calling any of our service centers.
We believe customer service and support are an integral part of our Oncology Systems competitive strategy. Growth in our service revenues has resulted from the increasing customer adoption of service contracts as the sophistication and installed base of our products increase. We also believe superior service plays an important role in marketing and selling medical products and systems, particularly as the products become more complex. Nevertheless, some of our customers use their own internal biomedical engineering organizations and/or independent service organizations to service equipment after the warranty period expires and therefore do not enter into agreements with us for extended service.
Our Proton Solutions business sells our proton therapy equipment generally with a 12-month warranty. Upon transfer of a treatment room to a customer, we generally begin generating service revenues by providing on-site proton therapy system technical operation and maintenance support services, which typically are for relatively long-term periods (e.g., a five-year term or longer). We believe customer service and support are an integral part of our Proton Solutions competitive strategy.
Our Interventional Solutions business sells cryoablation and microwave ablation systems with a 12-month warranty. Our cryoablation systems require annual preventive maintenance and our equipment servicing is handled by factory trained service personnel across the globe. Our product support department offers technical assistance and replacement parts to our authorized distributors and to those customers who choose to perform their own service.
Manufacturing and Supplies
We manufacture our medical linear accelerators in Palo Alto, California; Beijing, China; and Crawley, United Kingdom. We manufacture some of our accessory products in Crawley, United Kingdom; Baden, Switzerland; Helsinki, Finland; Toulouse, France; and Winnipeg, Canada. We manufacture our high dose rate brachytherapy systems in Haan, Germany and our brachytherapy treatment planning products in Baden, Switzerland; and Charlottesville, Virginia. We manufacture IDENTIFY in Germany. We manufacture Calypso components in Seattle, Washington. We manufacture components and sub-systems for our proton therapy products and systems in Troisdorf, Germany. These facilities employ state-of-the-art manufacturing techniques, and several have been honored by the press, governments and trade organizations for their commitment to quality improvement. These manufacturing facilities are certified under International Standards Organization (“ISO”) 13485 (for medical devices) and have other regulatory clearances in all markets served.
Manufacturing processes at our various facilities include machining, fabrication, subassembly, system assembly and final testing. Our quality assurance program includes various quality control measures from inspection of raw materials, purchased parts and assemblies through online inspection. We outsource the manufacturing of many major subassemblies and perform system design, assembly and testing in house. We believe outsourcing enables us to reduce or maintain fixed costs and capital expenditures, while also providing us with the flexibility to increase production capacity.
We purchase material and components from various suppliers that are either standard products or customized to our specifications. We obtain some of the components included in our products from a limited group of suppliers or from a single source supplier, such as: the radioactive sources for high dose afterloaders; klystrons for linear accelerators; and radiofrequency components, magnets, patient positioning systems and gantry hardware for proton therapy systems. We require certain raw materials such as tungsten, lead and copper for Oncology Systems; and high-grade steel, high-grade copper and iron for the Proton Solutions business. Worldwide demand, availability and pricing of these raw materials have been volatile, and we expect that availability and pricing will continue to fluctuate in the future.
We design and manufacture our cryoablation and microwave ablation products in our Austin, Texas facility. Our Austin manufacturing facility is certified under ISO 13485 (for medical devices). Our quality assurance program includes various quality control measures from inspection of raw materials, purchased parts and assemblies through online inspection. We purchase material and components from qualified suppliers that are either standard products or customized to our specifications. We outsource the manufacturing of some of our accessory microwave products to a third party in Colorado.
We design and manufacture our embolic particles (Gelatin and PVA particles) in China. The embolic microspheres (Embozene, Oncozene and Tandem) that we acquired from Boston Scientific in August 2019 are currently manufactured by Boston Scientific in their United States and Ireland facilities under a manufacturing agreement.
Research and Development
Developing products, systems and services based on advanced technology is essential to our ability to compete effectively in the marketplace. We maintain a research and development and engineering staff responsible for product design and engineering.
Within Oncology Systems, our development efforts focus on enhancing the reliability and performance of existing products and developing new products. This development is conducted primarily in the United States, Switzerland, Canada, England, Finland, Germany, India and China. In addition, we support research and development programs at selected hospitals and clinics. Current areas for development within Oncology Systems include linear accelerator systems and accessories for medical applications, information systems, radiation treatment planning software, image processing software, imaging devices, patient positioning and equipment diagnosis and maintenance tools. Development for our high-energy linear accelerators is focused on improvements in accelerator technology, size, and mobility to address the needs of our customers in the market. Within Oncology Systems, we also have an Applied Research group, which focuses on disruptive technologies and new capability incubation.
Within Proton Solutions, our development efforts focus on accelerating treatment delivery, machine-learning based treatment planning, integrating patient set-up, motion management and remote service capabilities, as well as reducing the size and cost of our proton therapy system. We expect that, in order to realize the full potential of the Proton Solutions business, we will need to continue to invest substantial resources to continue to develop proton therapy technology.
Within Interventional Solutions, our development efforts focus on introducing new and innovative products and enhancing existing offerings. We achieve this through internal product development, acquisition, technology licensing and strategic alliances. We recognize the importance of continued investment in research and development efforts, guided by our strategic intent, key opinion leaders and global oncology community feedback.
Product and Other Liabilities
Our business exposes us to potential product liability claims that are inherent in the manufacture, sale, installation, servicing and support of medical devices and other devices that deliver radiation. Because our products are involved in the intentional delivery of radiation to the human body and other situations where people may come in contact with radiation, the collection and storage of patient treatment data for medical analysis and treatment delivery, the planning of radiation treatment and diagnostic imaging of the human body, and the diagnosis of medical problems, the possibility for significant injury and/or death exists.
Our medical products operate within our customers’ facilities and network systems, and under quality assurance procedures established by the facilities that ultimately deliver treatments to patients. Human and other errors or accidents may arise from the operation of our products in complex environments, particularly with products from other vendors, where interoperability or data sharing protocol may not be optimized even though the equipment or system operates according to specifications. As a result, we may face substantial liability to patients, our customers and others for damages resulting from faulty, or allegedly faulty, design, manufacture, installation, servicing, support, testing or interoperability of our products with other products, or their misuse or failure, as well as liability related to the loss or misuse of private patient data, including resulting from unauthorized intrusion into our products. We may also be subject to claims for property damages or economic loss related to or resulting from any errors or defects in our products, or the installation, servicing and support of our products. Any accident or mistreatment could subject us to legal costs, litigation, adverse publicity and damage to our reputation, whether or not our products or services were a factor. In addition, if a product we design or manufacture were defective (whether due to design, labeling or manufacturing defects, improper use of the product or other reasons), or found to be so by a competent regulatory authority, we may be required to correct or recall the product and notify other regulatory authorities. We maintain limited product liability and healthcare professional liability insurance coverage and currently do not maintain any errors and omissions insurance.
Government Regulation
U.S. Regulations
Laws governing marketing a medical device. In the United States, our products and operations are subject to extensive regulation by federal governmental authorities, such as the FDA, Nuclear Regulatory Commission (“NRC”), and state and local regulatory agencies, such as the state of California and other U.S. states, to ensure the devices are safe and effective and comply with laws governing products which emit, produce or control radiation. Similar international regulations apply overseas. These regulations, which include the U.S. Food, Drug and Cosmetic Act (the “FDC Act”) and regulations promulgated by the FDA, govern, among other things, the design, development, testing, manufacturing, packaging, labeling, distribution, import/export, sale and marketing and disposal of medical devices, post market surveillance and reporting of serious injuries and death, repairs, replacements, recalls and other matters relating to medical devices, radiation emitting devices and devices utilizing radioactive by-product material. State regulations are extensive and vary from state to state. Our Oncology Systems and Interventional Solutions equipment and software, as well as proton therapy systems offered by our
Proton Solutions business, constitute medical devices subject to these regulations. Under the FDC Act, each medical device manufacturer must comply with quality system regulations that are strictly enforced by the FDA.
Unless an exemption applies, the FDA requires that the manufacturer of a new medical device or a new indication for use of, or other significant change in, existing currently marketed medical device obtain either 510(k) premarket notification clearance or premarket approval (“PMA”) before it can market or sell those products in the United States. We do not manufacture any Class III medical devices, which require PMA. Certain of our products, like our radiation delivery systems manufactured by our Oncology Systems business and proton therapy systems manufactured by our Proton Solutions business, are Class II medical devices that require 510(k) clearance, while our other products are exempt from 510(k) clearance. Modifications or enhancements to a product that could significantly affect its safety or effectiveness, or that would constitute a major change in the intended use of the device, technology, materials, labeling, packaging, or manufacturing process may also require a new 510(k) clearance. Manufacturers make the initial determination whether a change to a cleared device requires a new 510(k) clearance, but the FDA can review any such decision. If the FDA disagrees with the manufacturer’s decision not to seek a new 510(k) clearance or PMA approval, as applicable, for a change, it may retroactively require the manufacturer to seek 510(k) clearance or PMA approval. The FDA can also require the manufacturer to cease marketing and selling the product in the United States and/or recall the product until 510(k) clearance or PMA approval is obtained.
In 2011, the FDA issued a draft guidance that, if finalized and implemented, would have resulted in manufacturers needing to seek a significant number of new clearances for changes made to legally marketed devices. Since then, the FDA has withdrawn that guidance leading to a final guidance on changes issued in October 2017 that gives industry more flexibility than under the 2011 draft. Under the current guidance and applicable regulations, if we make a change to a current product, we must be able to show that the modified product is substantially equivalent to a legally marketed device. If we cannot do so, we must seek premarket approval for the changed product through a PMA application unless the FDA grants a request, under the “de novo” process, to reclassify the proposed product so that it does not require PMA. In that event, a premarket notification submission - or “510(k)” - or even no submission at all may be possible, depending on how the FDA views the risk associated with the proposed changed product. Under the PMA process, the applicant submits extensive supporting data, including, in most cases, data from clinical studies, in the PMA application to establish reasonable assurance of the safety and effectiveness of the product. This process typically takes at least one to two years from the date the PMA is accepted for filing, but can take significantly longer for the FDA to review. In addition, to secure PMA approval, an applicant must demonstrate, usually via an FDA inspection, that the medical device subject to the PMA conforms to FDA’s Quality Systems Regulations which implement Good Manufacturing Practice ("GMP") requirements.
Quality systems. Our manufacturing operations for medical devices, and those of our third-party suppliers, are required to comply with the FDA’s Quality System Regulation (“QSR”), as well as other federal and state regulations for medical devices and radiation emitting products. The QSR requires that each manufacturer establish a quality systems program by which the manufacturer monitors the manufacturing process and maintains records that show compliance with FDA regulations and the manufacturer’s written specifications and procedures relating to the devices. QSR compliance is necessary to receive and maintain FDA clearance or approval to market new and existing products. The FDA makes announced and unannounced periodic and on-going inspections of medical device manufacturers to determine compliance with the QSR. If in connection with these inspections, the FDA believes the manufacturer has failed to comply with applicable regulations and/or procedures, it may issue observations that would necessitate prompt corrective action. If FDA inspection observations are not addressed and/or corrective action taken in a timely manner and to the FDA’s satisfaction, the FDA may issue a Warning Letter (which would similarly necessitate prompt corrective action) and/or proceed directly to other forms of administrative and judicial enforcement actions. Failure to respond timely to FDA inspection observations, a Warning Letter or other notice of noncompliance and to promptly come into compliance could result in fines, injunctions, civil penalties, delays, suspension or withdrawal of clearances, seizures or recalls of products, operating restrictions, injunctions involving partial or total shutdown of production facilities, prohibition on export or import and criminal prosecution. Such actions may have further indirect consequences for the manufacturer both inside and outside of the United States and may adversely affect the reputation of the manufacturer and the product.
Radiation Control Regulations. Our products that use radioactive material, such as brachytherapy sources, are subject to the NRC clearance and approval requirements, and the manufacture and sale of these products are subject to federal and state regulations that vary from state to state and among regions. The manufacture, distribution, installation and service (and decommissioning and removal) of medical devices using radioactive material or emitting radiation also requires a number of licenses and certifications. Service of these products must also be done in accordance with a specific radioactive materials license. In addition, the handling and disposal of radioactive materials resulting from the manufacture, use or disposal of our products may impose significant requirements. Sites for the lawful disposal of materials generated by the manufacture, use or decommissioning of our products may no longer accept these materials in the future, or may accept them on unfavorable terms.
Regulations on Advertising and Promotions; Interactions with Healthcare Providers. The FDA and the Federal Trade Commission also regulate advertising and promotion of our products to ensure that the claims we make are consistent with our regulatory clearances, that there is competent and reliable scientific evidence to substantiate the claims, that our advertising fairly balances benefit and risk information, and that our promotional labeling and advertising is neither false nor misleading. We may not promote or advertise our products for uses not within the scope of our intended use statement in our clearances or approvals or make unsupported safety and effectiveness claims.
Additionally, we are members of AdvaMed, a global trade association of companies that develop, produce, manufacture and market Medical Technologies. Varian subscribes to the AdvaMed Code of Ethics on Interactions with U.S. Health Care Professionals. The AdvaMed Code provides companies with guidance on ethical interactions and relationships with Health Care Professionals. Also, we are subject to the Physician Payments Sunshine Act which requires medical product manufacturers to disclose annually any payments or other transfers of value made to U.S. physicians or teaching hospitals.
Electrical Safety and Environmental Regulations. It is also important that our products comply with electrical safety and environmental standards, such as those of Underwriters Laboratories, the Canadian Standards Association, and the International Electrotechnical Commission. In addition, the manufacture and distribution of medical devices utilizing radioactive material requires a specific radioactive material license. For the United States, manufacture and distribution of these radioactive sources and devices also must be in accordance with a model specific certificate issued by either the NRC or by a state regulatory authority. In essentially every country and state, installation and service of these products must be in accordance with a specific radioactive materials license issued by the applicable radiation control agency. We are also subject to a variety of additional environmental laws regulating our manufacturing operations and the handling, storage, transport and disposal of hazardous materials, and which impose liability for the cleanup of any contamination from these materials. For a further discussion of these laws and regulations, see “Critical Accounting Estimates” in MD&A, and Note 9, "Commitments and Contingencies," of the Notes to the Consolidated Financial Statements.”
Data Privacy Laws. Data protection legislation is becoming increasingly common in the United States at both the federal and state level. For example, in June 2018, the State of California enacted the California Consumer Privacy Act of 2018 ( “CCPA”), which will come into effect on January 1, 2020. Unless an exemption applies, the CCPA requires companies that process information on California residents to make new disclosures to consumers about their data collection, use and sharing practices, allows consumers to opt out of certain data sharing with third parties and provides a new cause of action for data breaches. Additionally, the Federal Trade Commission and many state attorney generals are interpreting federal and state consumer protection laws to impose standards for the online collection, use, dissemination and security of data. The compliance and other burdens imposed by the European Union ("EU") General Data Protection Regulation ("GDPR"), CCPA and similar privacy laws and regulations may be substantial since they are subject to differing interpretations and implementation among jurisdictions. The restrictions imposed by such laws and regulations may limit the use and adoption of our services, reduce overall demand for our services, require us to modify our data handling practices, slow the pace at which we close sales transactions and impose additional costs and burdens.
Other United States Healthcare Laws. As a participant in the healthcare industry, we are also subject to federal and state laws and regulations pertaining to patient privacy and data security, fraud and abuse and physician payment transparency. The laws and regulations and their enforcement are constantly undergoing change, and we cannot predict what effect, if any, changes to these laws and regulations may have on our business. Government regulation also may cause considerable delay or even prevent the marketing and full commercialization of future products or services that we may develop. These healthcare laws include:
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The Medicare and Medicaid “anti-kickback” laws, and similar state laws, that prohibit payments or other remuneration intended to induce hospitals, physicians or others either to refer patients, or to purchase, lease or order, or arrange for or recommend the purchase, lease or order of healthcare products or services for which payment may be made under federal and state healthcare programs, such as Medicare and Medicaid. These laws affect our sales, marketing and other promotional activities by limiting the kinds of financial arrangements we may have with hospitals, physicians or other potential purchasers of our products. They particularly impact how we structure our sales offerings, including discount practices, customer support, education and training programs, physician consulting, research grants and other service arrangements. These laws are broadly written, and it is often difficult to determine precisely how these laws will be applied to specific circumstances.
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Federal and state “false claims” laws generally prohibit knowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid or other government payors that are false or fraudulent, or for items or services that were not provided as claimed. Although we do not submit claims directly to payors,
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manufacturers can be, and have been, held liable under these laws if they are deemed to “cause” the submission of false or fraudulent claims by providing inaccurate billing or coding information to customers, or through certain other activities, including promoting products for uses not approved or cleared by the FDA.
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State and federal transparency laws, including laws in Massachusetts and Vermont, and the federal Physician Payment Sunshine Act, which require, among other things, the disclosure of equity ownership and payments to physicians, healthcare providers and hospitals.
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From time to time, these laws and regulations may be revised or interpreted in ways that could make it more difficult for our customers to conduct their businesses, such as recent proposed revisions to the laws prohibiting physician self-referrals, and such revisions could have an adverse effect on the demand for our products, and therefore our business and results of operations.
Medicare and Medicaid Reimbursement
The federal and state governments of the United States establish guidelines and pay reimbursements to hospitals and free-standing clinics for diagnostic examinations and therapeutic procedures under Medicare at the federal level and Medicaid at the state level. Private insurers often establish payment levels and policies based on reimbursement rates and guidelines established by the government.
The federal government and the Congress review and adjust rates annually, and from time to time consider various Medicare and other healthcare reform proposals that could significantly affect both private and public reimbursement for healthcare services, including radiotherapy and radiosurgery, in hospitals and free-standing clinics. State government reimbursement for services is determined pursuant to each state’s Medicaid plan, which is established by state law and regulations, subject to requirements of federal law and regulations. In the past, we have seen our customers’ decision-making process complicated by the uncertainties surrounding reimbursement rates for radiotherapy and radiosurgery in the United States. In July 2019, the CMS proposed the APM pilot program for radiation oncology, intended to test whether an episode-based payment structure across a cohort of U.S. hospitals and freestanding cancer centers would reduce Medicare expenditures, while preserving or enhancing the quality of care. We expect that CMS will announce the APM rules in late 2019, although the exact timing and details of the APM are uncertain.
The provisions of the Affordable Care Act went into effect in 2012. Specifically, one of the components of the law is a 2.3% excise tax on sales of most medical devices, which include our Oncology Systems products, which started on January 1, 2013. In January 2018, President Trump signed into law a spending package that included a two-year moratorium on the medical device excise tax starting January 1, 2018 and ending December 31, 2019. This tax has had, and may continue to have, a negative impact on our gross margin when the moratorium expires.
The Medicare Access and CHIP Reauthorization Act ("MACRA") became effective beginning January 1, 2017. MACRA made numerous changes to Medicare, Medicaid, and other healthcare related programs. These changes include new systems for establishing the annual updates to payment rates for physicians’ services in Medicare as well as certain electronic health record reporting requirements for providers. Any changes in reimbursement policies and other legislative initiatives aimed at or having the effect of reducing healthcare costs associated with Medicare and other government healthcare programs could impact our business.
Various healthcare reform proposals have also emerged at the state level, and we are unable to predict which, if any of these proposals will be enacted. We believe that the uncertainty created by healthcare reform in the United States has complicated our customers’ decision-making process and impacted our Oncology Systems and Proton Solutions businesses, and may continue to do so.
The sale of medical devices including radiotherapy products, the referral of patients for diagnostic examinations and treatments utilizing such devices, and the submission of claims to third-party payors (including Medicare and Medicaid) seeking reimbursement for such services, are subject to various federal and state laws pertaining to healthcare “fraud and abuse.” These laws include physician self-referral prohibitions, anti-kickback laws and false claims laws. Subject to enumerated exceptions, the federal physician self-referral law, also known as Stark II, prohibits a physician from referring Medicare or Medicaid patients to an entity with which the physician (or a family member) has a financial relationship, if the referral is for a “designated health service,” which is defined explicitly to include radiology and radiation therapy services. Anti-kickback laws make it illegal to solicit, induce, offer, receive or pay any remuneration in exchange for the referral of business, including the purchase of medical devices from a particular manufacturer or the referral of patients to a particular supplier of diagnostic
services utilizing such devices. False claims laws prohibit anyone from knowingly and willfully presenting, or causing to be presented, claims for payment to third-party payors (including Medicare and Medicaid) that are false or fraudulent, for services not provided as claimed, or for medically unnecessary services. The Office of the Inspector General prosecutes violations of fraud and abuse laws and any violation may result in criminal and/or civil sanctions including, in some instances, imprisonment and exclusion from participation in federal healthcare programs such as Medicare and Medicaid. Varian needs to comply with all applicable laws related to federal healthcare programs in transactions with health care professionals.
Foreign Regulations
Our operations, sales and service of our products outside the United States are subject to regulatory requirements that vary from country to country and may differ significantly from those in the United States. In general, our products are regulated outside the United States as medical devices by foreign governmental agencies similar to the FDA.
Marketing a medical device internationally. In order for us to market our products internationally, we must obtain clearances or approvals, or registrations, for products and product modifications. We are required to affix the CE mark to our products in order to sell them in member countries of the European Economic Area (“EEA”). The CE mark is an international symbol of adherence to certain essential principles of safety and effectiveness, which once affixed enables a product to be sold in member countries of the EEA. The CE mark is also recognized in many countries outside the EEA, such as Switzerland and Australia, and can assist in the clearance process. In order to receive permission to affix the CE mark to our products, we must obtain Quality System certification, e.g., ISO 13485, and must otherwise have a quality management system that complies with the EU Medical Device Directive. The ISO promulgates standards for certification of quality assurance operations. We are certified as complying with ISO 13485 for our medical devices. The European Union ("EU") Commission published a new Medical Device Regulation in 2017, providing a three-year transition period until May 2020, at which time, the existing Directives will be repealed. The Medical Device Regulation will change multiple aspects of the existing regulatory framework, such as higher clinical evidence requirements and introduce several new requirements, such as Unique Device Identification and many other post-market obligations. Thus, the new Medical Device Regulation significantly modifies and intensifies the compliance requirements for the industry.
Several Asian countries, including China and Japan, have adopted their own regulatory schemes. To import medical devices into Japan, the requirements of Japan’s Pharmaceutical New Medical Act Device Regulation must be met and a “shonin,” the approval to sell medical products in Japan, must be obtained. Similarly, in China a product registration license issued by the National Medical Product Administration are required to sell medical devices in that country. Obtaining such license approvals for our products can be time-consuming and burdensome and can cause us to delay marketing or sales of our products in such countries. Similarly, prior to selling a device in Canada, manufacturers of Class II, III and IV devices must obtain a medical device license. We sell Class II and Class III devices in Canada. Additionally, many countries have laws and regulations relating to radiation and radiation safety that also apply to our products. In most countries, radiological regulatory agencies require some form of licensing or registration by the facility prior to acquisition and operation of an X-ray generating device or a radiation source. The handling, transportation and the recycling of radioactive metals and source materials are also highly regulated.
A number of countries, including the members of the EU, have implemented or are implementing regulations that would require manufacturers to dispose, or bear certain disposal costs, of products at the end of a product’s useful life and restrict the use of some hazardous substances in certain products sold in those countries.
CTSI operations. We are subject to laws and regulations in India and Sri Lanka in relation to the operation of a healthcare establishment. The laws apply to the governing, commissioning and operating of the centers; the practice and conduct of medical professionals; management of patients; sale and storage of drugs and safe medication; employment and management of manpower; the safety of patients, staff and the public; and environmental protection. In order to service our patients, we must obtain the relevant licenses and/or registrations, adhere to set standards and are subject to inspections required for the operations of our centers.
Data Privacy Laws. Laws and regulations related to the collection, processing, storage, transfer and use of personal data are evolving globally. The GDPR took effect in May 2018, and other foreign jurisdictions are also going through privacy reform. Particularly within Europe, data protection legislation is comprehensive and complex and there has been a recent trend toward more stringent enforcement of requirements regarding protection and confidentiality of personal data. The compliance and other burdens imposed by the GDPR and similar privacy laws and regulations may be substantial since they are subject to differing interpretations and implementation among jurisdictions. The restrictions imposed by such laws and regulations may limit the use and adoption of our services, reduce overall demand for our services, require us to modify our data handling practices, slow the pace at which we close sales transactions and impose additional costs and burdens. In addition, non-
compliance could result in proceedings against us by governmental entities or others, significant fines, could negatively impact our reputation and may otherwise adversely impact our business, financial condition and operating results. Particularly within Europe, data protection legislation is comprehensive and complex and there has been a recent trend toward more stringent enforcement of requirements regarding protection and confidentiality of personal data.
Other applicable international regulations. We are also subject to foreign laws and regulations that apply to manufacturers of radiation emitting devices and products utilizing radioactive materials, as well as laws and regulations of general applicability relating to matters such as environmental protection, safe working conditions, manufacturing practices and other matters. In addition, our sales of products in foreign countries are also subject to regulation of matters such as product standards, packaging requirements, labeling requirements, import restrictions, environmental and product recycling requirements, trade regulations, duties and tax requirements. In some countries, we rely on our foreign distributors and agents to assist us in complying with foreign regulatory requirements. These laws and regulations are often comparable to, if not more stringent than, the equivalent laws and regulations in the United States. In addition, sales overseas are also affected by regulation of matters such as product standards, packaging, labeling, environmental and product recycling requirements, import and export restrictions, tariffs, duties and taxes. In some countries, we rely on our foreign distributors and agents to assist us in complying with foreign regulatory requirements, and we cannot be sure that they will always do so.
We are also subject to international “fraud and abuse” laws and regulations, as well as false claims and misleading advertisement laws. From time to time, these laws and regulations may be revised or interpreted in ways that could make it more difficult for our customers to conduct their businesses, which could have an adverse effect on the demand for our products, and therefore our business and results of operations. The laws and regulations and their enforcement are constantly undergoing change, and we cannot predict what effect, if any, changes to these laws and regulations may have on our business.
Anti-Corruption Laws and Regulations
We are subject to the U.S. Foreign Corrupt Practices Act and anti-corruption laws, and similar laws in foreign countries, such as the U.K. Bribery Act of 2010 and the Law “On the Fundamentals of Health Protection in the Russian Federation.” In general, there is a worldwide trend to strengthen anti-corruption laws and their enforcement, and the healthcare industry and medical equipment manufacturers have been particular targets of these investigation and enforcement efforts. Any violation of these laws by us or our agents or distributors could create a substantial liability for us, subject our officers and directors to personal liability and cause a loss of reputation in the market.
Transparency International’s 2016 Corruption Perceptions Index measured the degree to which public sector corruption is perceived to exist in 176 countries/territories around the world, and found that approximately sixty-nine percent of the countries in the index, including many that we consider to be high growth areas for our products, such as China, India, Russia and Brazil, scored below 50, on a scale from 100 (very clean) to 0 (highly corrupt). We currently operate in many countries where the public sector is perceived as being more or highly corrupt and our strategic business plans include expanding our business in regions and countries that are rated as higher risk for corruption activity by Transparency International.
Increased business in higher risk countries could subject us and our officers and directors to increased scrutiny and increased liability. In addition, becoming familiar with and implementing the infrastructure necessary to comply with laws, rules and regulations applicable to new business activities and mitigating and protecting against corruption risks could be quite costly. Failure by us or our agents or distributors to comply with these laws, rules and regulations could delay our expansion into high-growth markets and could adversely affect our business.
Patent and Other Proprietary Rights
We place considerable importance on obtaining and maintaining patent, copyright and trade secret protection for significant new technologies, products and processes, because of the length of time and expense associated with bringing new products through the development process and to the marketplace.
We generally rely upon a combination of patents, copyrights, trademarks, trade secret and other laws, and contractual restrictions on disclosure, copying and transferring title, including confidentiality agreements with vendors, strategic partners, co-developers, employees, consultants and other third parties, to protect our proprietary rights in the developments, improvements and inventions that we have originated and which are incorporated in our products or that fall within our fields of interest. As of September 27, 2019, we owned 577 patents issued in the United States and 447 patents issued throughout the rest of the world and had 478 patent applications on file with various patent agencies worldwide. We intend to file additional patent applications as appropriate. We have trademarks, both registered and unregistered, that are maintained and enforced to
provide customer recognition for our products in the marketplace. We also have agreements with third parties that provide for licensing of patented or proprietary technology, including royalty bearing licenses and technology cross licenses.
Environmental Matters
For a discussion of environmental matters, see “Critical Accounting Estimates” in MD&A and Note 9, "Commitments and Contingencies," of the Notes to the Consolidated Financial Statements, which discussions are incorporated herein by reference.
Tariff Measures
Between July 2018 and May 2019, the Trump Administration imposed a series of tariffs, ranging from 5% to 25%, on numerous products imported into the United States from China, including Varian’s radiotherapy systems manufactured in China and certain components used in our manufacturing and service activities. In July and August of 2018, China retaliated against the U.S. tariffs by imposing its own series of tariffs, ranging from 10% to 25%, on certain products imported into China from the United States, including Varian’s radiotherapy systems and certain manufacturing and service components.
We participated in the Office of the U.S. Trade Representative (“USTR”) process to seek product-specific exclusions from the U.S. tariffs on Chinese imports. To date, USTR has granted tariff exclusions for four products: certain radiotherapy systems manufactured in China, as well as three key components of the radiation therapy systems that we manufacture in the United States: multi-leaf collimators, certain printed circuit board assemblies and tungsten shielding. We submitted an additional U.S. exclusion request in September 2019, in relation to a manufacturing component, which request is pending.
In June and July 2019, Varian submitted formal requests to the Chinese government for exclusions from the Chinese retaliatory tariffs for manufacturing inputs, service parts and radiotherapy systems imported into China from the United States. In September 2019, the Chinese government granted a tariff exclusion for medical linear accelerators, including our radiotherapy systems, with retroactive effect. The other exclusion requests are still pending.
The U.S. and Chinese government tariff exclusions are for one-year periods, with anticipated renewal processes.
Employees
As of September 27, 2019, we had 10,062 full-time and part-time employees worldwide, including 3,438 in the United States and 6,624 in international locations. None of our employees based in the United States are unionized or subject to collective bargaining agreements. Employees based in some other countries may, from time to time, be represented by works councils or unions or subject to collective bargaining agreements. We consider our relations with our employees to be good.
Information About Our Executive Officers
The biographical summaries of our executive officers, as of November 1, 2019, are as follows:
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Name
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Age
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Position
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Dow R. Wilson
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60
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President and Chief Executive Officer
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Kolleen T. Kennedy
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60
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President, Proton Solutions and Chief Growth Officer
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Christopher A. Toth
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40
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President, Oncology Systems
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Gary E. Bischoping, Jr.
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51
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Senior Vice President, Finance and Chief Financial Officer*
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John W. Kuo
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56
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Senior Vice President, General Counsel and Corporate Secretary
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J. Michael Bruff
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50
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Senior Vice President, Finance and Investor Relations *
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Effective December 1, 2019, Gary E. Bischoping, Jr. will become President, Interventional Solutions, and J. Michael Bruff will succeed Mr. Bischoping as Senior Vice President, Finance and Chief Financial Officer. Effective December 1, 2019, Mr. Bischoping will no longer be an executive officer and J. Michael Bruff will become one.
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Dow R. Wilson was appointed President and Chief Executive Officer effective September 29, 2012. Mr. Wilson served as Corporate Executive Vice President and Chief Operating Officer from October 2011 through September 2012 and as Corporate Executive Vice President and President, Oncology Systems from August 2005 through September 2011. Mr. Wilson served as Corporate Vice President and President, Oncology Systems from January 2005 to August 2005. Prior to joining the Company in January 2005, Mr. Wilson was Chief Executive Officer of the Healthcare-Information Technologies business in General Electric (a diversified technology and services company), from 2003 to 2005. During the previous 18 years, Mr. Wilson held
various management positions within General Electric. Mr. Wilson holds a B.A. degree in English from Brigham Young University and an M.B.A. degree from Dartmouth’s Amos Tuck School of Business. Mr. Wilson serves on the board of directors at Agilent, Inc. Mr. Wilson also serves on the board of directors of industry associations AdvaMed and the US-India Strategic Partner Forum. In 2015, Mr. Wilson was appointed by President Obama to serve on a Presidential Advisory Council ("Council") for doing business in Africa; he recently completed a second term on the Council. Mr. Wilson served on the board of directors of Varex Imaging Corporation, our former Imaging Components business segment, from January 2017 to January 2018. He also served on the board of directors of Saba Software, Inc. (an e-learning software provider) from August 2006 to March 2015 and as the lead independent director of that board from August 2011 to March 2013. Mr. Wilson was appointed to our Board of Directors in September 2012.
Kolleen T. Kennedy was appointed President of Proton Solutions and Chief Growth Officer effective October 2018. Ms. Kennedy served as Executive Vice President and President, Oncology Systems from September 2014 to September 2018, and was Senior Vice President and President, Oncology Systems from October 2011 to September 2014. From January 2006 through September 2011, Ms. Kennedy served as Vice President, Oncology Systems Customer Service and Support. Prior to that, Ms. Kennedy was the Company’s Vice President, Oncology Systems Marketing, Product Management and Engineering from September 2004 to January 2006. Prior to becoming Vice President, Ms. Kennedy served in various marketing management positions since she joined the Company in 1997. Ms. Kennedy holds a B.S. degree in Radiation Oncology and a B.S. degree in Psychology, both from Wayne State University, as well as an M.S. degree in Medical Physics from the University of Colorado.
Christopher A. Toth was appointed President of Oncology Systems effective October 2018. Mr. Toth joined Varian in 2001 and has held multiple cross-functional roles and executive positions during his tenure with the company. Prior to his appointment as President of Oncology Systems, Mr. Toth served as President of Global Commercial and Field Operations from January 2017 to September 2018, where he was responsible for global sales strategy and execution for Oncology Systems and Proton Solutions. Additionally, in this role, Mr. Toth was responsible for global field service, applications training, market access and regional marketing for the Oncology Systems business. From September 2014 to January 2017, Mr. Toth was President, Oncology Systems Americas and from April 2011 to September 2014, Vice President, Global Marketing. Mr. Toth holds a B.A. degree in Business Administration with a concentration in Marketing from the Lundquist College of Business at the University of Oregon.
Gary E. Bischoping, Jr. was appointed Senior Vice President, Finance and Chief Financial Officer ("CFO") in May 2017. Effective December 1, 2019, Mr. Bischoping, Jr. will become President, Interventional Solutions and no longer serve as CFO. Prior to joining the Company, Mr. Bischoping was with Dell Technologies for 17 years where he held several management roles including CFO of its Client Solutions Group from 2016 to 2017, CFO of Enterprise Solutions Group and Commercial Sales from 2013 to 2016, CFO of its Commercial Business from 2012 to 2013, and VP and Treasurer from 2008 to 2012. Before joining Dell, Mr. Bischoping worked in financial management consulting for Stern Stewart & Company, Xerox and the SK Group. Mr. Bischoping earned his M.B.A. degree from the Simon School of Business at the University of Rochester and a B.S. degree in Accounting from the State University of New York at Oswego. He passed the Certified Public Accountants examination in 1991.
John W. Kuo was appointed Senior Vice President, in addition to being General Counsel and Corporate Secretary, in February 2012. Prior to that, he served as Corporate Vice President and General Counsel from July 2005 through January 2012 and as Corporate Secretary since February 2005. Mr. Kuo joined the Company as Senior Corporate Counsel in March 2003 and became Associate General Counsel in March 2004. Prior to joining the Company, Mr. Kuo was General Counsel and Secretary at BroadVision, Inc. (an e-commerce software provider) and held senior legal positions at 3Com Corporation (a networking equipment provider). Mr. Kuo has previously been with the law firms of Gray Cary Ware & Freidenrich (now DLA Piper) and Fulbright & Jaworski. Mr. Kuo holds a B.A. degree from Cornell University and a J.D. degree from Berkeley Law at the University of California at Berkeley.
J. Michael Bruff, who currently serves as Senior Vice President, Finance and Investor Relations will succeed Mr. Bischoping as CFO effective December 1, 2019. Since joining the Company, Mr. Bruff served as Vice President of Investor Relations between August 2017 and February 2018 and has served as Senior Vice President, Finance and Investor Relations from February 2018 to the present. Prior to joining the Company, Mr. Bruff worked for Dell Technologies for 19 years in both domestic and international roles, most recently as Senior Vice President of North America Sales Strategy & Planning. Previously, he served as Senior Vice President and CFO of Dell's Asia Pacific and Japan Commercial Business and Vice President and CFO of the Greater China Commercial Business. He also held several other finance leadership roles in commercial finance, financial planning and analysis, internal audit and Enterprise Solutions Group finance. In addition, Mr. Bruff was Vice President, Global Services Accounting and Finance at CA, Inc. and held a variety of finance and reporting roles at MCI Telecommunications. Mr.
Bruff started his career in auditing and accounting at Deloitte & Touche. Mr. Bruff holds a B.S. degree in Accounting and a B.A degree in Economics from the University of Maryland.
Distribution
On January 28, 2017 (the "Distribution Date"), we completed the separation and distribution (the "Distribution") of Varex Imaging Corporation ("Varex"), our former Imaging Components business segment. On the Distribution Date, each of our stockholders of record as of the close of business on January 20, 2017 (the "Record Date") received 0.4 of a share of Varex common stock for every one share of our common stock owned as of the Record Date. Varex is now an independent publicly traded company and is listed on The NASDAQ Global Select Market under the ticker symbol "VREX."
Information Available to Investors
As soon as reasonably practicable after our filing or furnishing the information to the SEC, we make the following available on the Investors page of our website http://www.varian.com: our annual reports on Form 10-K; quarterly reports on Form 10-Q; current reports on Form 8-K (including any amendments to those reports); and proxy statements. Our Code of Conduct, Corporate Governance Guidelines and the charters of the Audit Committee, Compensation and Management Development Committee, Ethics and Compliance Committee, Nominating and Corporate Governance Committee and Executive Committee are also available on the Investors page of our website. Investors and others should note that we announce material financial and operational information to our investors using our investor relations website (http://investors.varian.com/), press releases, SEC filings and public conference calls and webcasts. Please note that information on, or that can be accessed through, our website is not deemed “filed” with the SEC and is not to be incorporated by reference into any of our filings under the Securities Act of 1933, as amended (the “Securities Act”), or the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
Item 1A. Risk Factors
The following risk factors and other information included in this Annual Report on Form 10-K should be carefully considered. The occurrence of any of the following risks or of unknown risks and uncertainties may adversely affect our business, operating results and financial condition.
RISKS RELATING TO OUR BUSINESSES
Our performance depends on successful improvements to our existing products and services, commercialization of new products and services and increasingly on our ability to anticipate emerging trends in oncology diagnosis, treatment and management.
The markets in which we operate are characterized by rapid change and technological innovation. Our performance depends on the successful commercialization of new products and services that reflect and respond to changes in the marketplace, technology and customer demands and increasingly on our ability to anticipate emerging trends in oncology diagnosis, treatment and management.
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Our Oncology Systems hardware and software products often have long development and government approval cycles, are technologically complex and must demonstrate high levels of performance and functionality to remain competitive.
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Our software products compete in markets characterized by rapid technological advances, changing delivery models, evolving standards and frequent new product introductions and enhancements. We are expanding our software product lines and investing in the development of cloud and software-as-a-service (“SaaS”) solutions. The development and introduction of new software platforms and delivery models, as well as different business models, is complex and involves many technological, regulatory and legal hurdles. We cannot assure you that we can successfully develop and implement such platforms or models or that our customers will accept them.
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Our Proton Solutions products require intensive planning, design, development, testing and capital commitment. Because of the large footprint and high price of many proton therapy systems, there is increasing demand for the development of smaller, more compact proton therapy systems. Although we have introduced our ProBeam® Compact single-room proton therapy solution and our ProBeam 360 single room and multi-room systems, other companies have more experience offering smaller, less expensive proton therapy systems. Our competitiveness will depend on our ability to continue to timely develop new technologies to reduce the size and price of our system or provide additional features and functionality that our competitors do not.
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Our Interventional Solutions business offers products for interventional oncology procedures and treatments, including cryoablation, microwave ablation and embolization The success of our Interventional Oncology business will depend on general market penetration and acceptance of interventional solutions among physicians, the medical community, healthcare payors and patients, and our ability to develop and successfully market technologically competitive products and win market share from other companies in spaces where they have greater resources than we do.
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In addition to hardware and software products for oncology care, we offer treatment planning and quality assurance as a service, which allows remote delivery and support of care in understaffed locations to utilize technology on a per patient basis. Our ability to realize the full potential of these services will depend heavily on our ability to deploy them using AI-based software solutions and developing such software solutions.
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We may need to spend more time and money than anticipated to develop and introduce new products, product enhancements or services. We may not be able to recover all or a meaningful part of our investments. New products may adversely impact orders and sales of our existing products or make them less desirable or even obsolete. In addition, certain costs, including installation and warranty costs, associated with new products may be disproportionately greater than the costs associated with existing products, and if we are unable to lower these costs over time, our operating results could be adversely affected.
Our ability to successfully develop and introduce new products, product enhancements and services depends, among other things, on our ability to:
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properly identify and respond to customer needs;
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demonstrate the value proposition of new products and services;
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limit the time required from proof of feasibility to routine production;
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timely and efficiently comply with internal quality assurance systems and processes;
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limit the timing and cost of regulatory approvals;
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accurately predict and control costs associated with inventory overruns or shortages caused by phase-in of new products and services and phase-out of old products and services;
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price our products and services competitively and profitably;
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manufacture, deliver and install our products in sufficient volumes on time, and accurately predict and control costs associated with manufacturing, installation, warranty and maintenance of the products; and
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manage customer demands for new and old products and services, and optimize complementary product lines and services.
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We cannot be sure that we will be able to successfully commercialize new products because commercialization involves compliance with complex quality assurance processes, including the Quality System Regulation (“QSR”) of the FDA. Failure to complete these processes on a timely and efficient basis could result in delays that could affect our ability to attract or retain customers, or could cause customers to delay or cancel orders.
In addition, a portion of our Oncology Systems’ product revenue is generally tied to installation and acceptance of the product, and our recognition of revenue associated with new products may be deferred where it takes longer to manufacture or install the new products. Customers may also decide not to upgrade their equipment, or customers may delay delivery of some of our more sophisticated products because of the longer preparation and renovation of treatment rooms required.
We compete in highly competitive markets, and we may lose market share to companies with greater resources or more effective technologies, or be forced to reduce our prices.
The markets for cancer treatment are characterized by rapidly evolving technology, intense competition and pricing pressure. In radiotherapy and radiosurgery markets, we compete primarily with Elekta AB and Accuray Incorporated. In addition, our software products compete with the product offerings of a variety of companies, such as Philips Medical Systems, RaySearch Laboratories AB and Brainlab AG.
New competitors may enter our markets and have already entered some of our newer markets such as radiosurgery, VMAT and proton therapy. Established enterprise software developers with greater software development capability may enter the markets for cancer treatment software. Some of these competitors may have greater financial, marketing and other resources. To compete successfully, we must provide technically superior, proven products that deliver more precise, cost-effective, high quality clinical capabilities, in a complete package of products and services, and do so ahead of our competitors.
As our Oncology Systems products are generally sold on a basis of total value to the customer, our business may suffer when purchase decisions are based solely upon price, which can happen if hospitals and clinics give purchasing decision authority to group purchasing organizations. New competitors may also delay the purchasing decisions of customers if customers decide to evaluate the products of such competitors along with ours, potentially extending our sales cycle and adversely affecting our gross orders and revenues.
The shift in the proportion of sales outside the United States towards emerging market countries, which typically purchase less complex, lower-priced products compared to more developed countries, and which usually have stiffer price competition and longer periods from placement of orders to revenue recognition, could also adversely impact our results of operations.
The market for proton therapy products is still developing and is characterized by rapidly evolving technology and pricing pressure. Our primary competitors in the proton therapy market are Hitachi Heavy Industries, Ion Beam Applications S.A. and Mevion Medical Systems. Our ability to compete successfully depends, in part, on our ability to lower our product costs, and develop and provide technically superior, proven products that deliver precise, cost-effective, high quality capabilities.
The market for interventional solutions products is relatively new, still developing and is marked by a wide variety of products, many of which have had varying degrees of market acceptance. Our primary competitors in the interventional solutions market include Boston Scientific Corp., Terumo Medical Corp., Merit Medical Systems, AngioDynamics, Medtronic and Johnson & Johnson, many of which have greater experience in the interventional oncology market and more financial and other resources than we do.
The successful development of alternative therapies for cancer (e.g. pharmaceutical treatments such as immunotherapy), increased efficacy information about new therapies or existing products, pricing decisions by competitors and the rate of market penetration by competitive products may render our products obsolete, result in lost market share for us, reduce utilization of our products, lower prices, and reduce product sales and operating margins.
The timing of our competitors’ introduction of products into the market could affect the market acceptance and market share of our products. Some competitors offer specialized products that provide, or may be perceived by customers to provide, a marketing advantage over our mainstream cancer treatment products. Also, some of our competitors may not be subject to the same standards, regulatory and/or other legal requirements that we are subject to, and therefore, they could have a competitive advantage in developing, manufacturing and marketing products and services. Any inability to develop, gain regulatory approval for and supply commercial quantities of competitive products to the market as quickly and effectively as our competitors could limit market acceptance of our products and reduce our sales. In addition, some of our smaller competitors could be acquired by larger companies that have greater financial strength and resources, which could enable them to compete more aggressively and effectively. Our competitors could also acquire some of our suppliers or distributors, which could disrupt supply or distribution arrangements and result in less predictable and reduced revenues in our businesses.
The interoperability of radiation oncology treatment products is becoming increasingly important, and sales of our products could fall if we fail to establish interoperability.
As radiation oncology treatment becomes more complex, our customers are increasingly focused on ease-of-use and interconnectivity. We have directed substantial product development efforts into (1) increasing the interconnectivity of our products for more seamless operation within a system, (2) making our software products easier to use and (3) reducing setup and treatment times to increase patient throughput. Our equipment and software are highly sophisticated, and a high level of training and education is required to use them safely and effectively.
We have emphasized an “open systems” approach that allows customers to “mix and match” our individual products, incorporate products from other manufacturers, share information with other systems or products and offer various methods of radiation and chemotherapy treatment. We have done this based on our belief that such interconnectivity will increase the acceptance and adoption of IMRT, IGRT and VMAT and will stimulate demand for our products. There are competitive “closed-ended” dedicated-use systems that place simplicity of use ahead of flexibility. If we have misjudged the importance to our customers of maintaining an “open systems” approach, or if we are unsuccessful in our efforts to increase interconnectivity, enhance ease-of-use and reduce setup and treatment times, our revenues could suffer. Obtaining and maintaining interoperability and compatibility can be costly and time-consuming. While we try to use standard published protocols for communication with widely-used oncology products manufactured by other companies, if we cannot do this, we may need to develop individual interfaces so that our products communicate correctly with other products.
When other companies modify the design or functionality of their products, this may affect their compatibility with our products. In addition, when we improve our products, customers may be reluctant to adopt our new technology due to potential interoperability issues. For example, a clinic may be unwilling to implement one of our new technologies because its third-party software does not yet communicate correctly with our new product. Our ability to obtain compatibility with products of other companies may depend on our ability to obtain adequate information from them regarding their products. In many cases, these third parties are our competitors and may schedule their product changes or delay their release of relevant information to place us at a competitive disadvantage.
When we modify our products to make them interoperable or compatible with third-party products, we may be required to obtain additional regulatory clearances. This process is costly and could delay our ability to release our products for commercial use. It is also possible that, despite our efforts, we may not be able to make our products interoperable or compatible with widely used third-party products or may only be able to do so at a prohibitive expense, making our products less attractive to our customers.
Disruption of our critical information systems or material cyberattacks or security breaches of our products may adversely affect our business and customer relations.
Information technology helps us operate efficiently, interface with and support our customers, maintain financial accuracy and efficiency, and produce our financial statements. There is an increasing threat of information security attacks for companies such as Varian. Because the techniques used to obtain unauthorized access, or to sabotage systems, change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. If we do not allocate and effectively manage the resources necessary to build and sustain the proper technology infrastructure, we could be subject to, among other things, transaction errors, processing inefficiencies, the loss of customers, business disruptions, or the loss of or damage to intellectual property through a security breach. Such security breaches could expose us to a risk of loss of information, litigation and possible liability to employees, customers and regulatory authorities. If our data management systems fail to effectively collect, secure, store, process and report relevant data for the operation of our business, whether due to equipment malfunction or constraints, software deficiencies, or human error, our ability to effectively plan, forecast and execute our business plan and comply with applicable laws and regulations will be impaired. Any such impairment could materially and adversely affect our financial condition and results of operations, and the timeliness with which we report our operating results internally and externally.
We manufacture and sell (i) hardware products that rely upon software systems to operate properly and (ii) software products that deliver treatment instructions and store confidential patient information. Both types of products often are connected to and reside within our customers' information technology infrastructures. While we have implemented security measures to protect our hardware and software products from unauthorized access, these measures may not be effective in securing these products, particularly since techniques used to obtain unauthorized access, or to sabotage systems, change frequently and generally are not recognized until launched against a target. Additionally, we are developing and offering cloud and SaaS software products which reside with and are hosted by third-party providers. A security breach, whether of our products, of our customers’ network security and systems or of third-party hosting services, could disrupt treatments occurring on our products, disrupt access to our customers' stored information, such as patient treatment delivery instructions, and could lead to the loss of, damage to or public disclosure of our customers’ stored information, including patient health information. Such an event could have serious negative consequences, including possible patient injury, regulatory action, fines, penalties and damages, reduced demand for our solutions, an unwillingness of our customers to use our solutions, harm to our reputation and brand, and time-consuming and expensive litigation, any of which could have an adverse effect on our financial results.
If we were to experience a significant cyberattack or security breach of our information systems or data, the costs associated with the investigation, remediation and potential notification of the breach to customers and counter-parties could be material.
We carry a limited amount of insurance for cybersecurity liability, and our insurance coverage may be inadequate. In the future, our insurance coverage may be expensive and/or not be available on acceptable terms or in sufficient amounts, if at all.
We may offer extended payment terms to certain customers, which could adversely affect our financial results.
We offer extended payment terms for certain qualified customers. As of September 27, 2019, customer contracts with remaining terms of more than one year amounted to approximately 4% of our net trade and unbilled receivables.
While we qualify customers to whom we offer extended payment terms, their financial positions may change adversely over the longer payment term. Many of the customers to which we offer such extended payment terms are located in underdeveloped legal systems for securing debt and enforcing collection of debt. Concerns over economic instability could also make it more difficult for us to collect outstanding receivables. This may result in an increase in payment defaults and uncollectible accounts, or could cause us to increase our bad debt expense, which would adversely affect our net earnings. In addition, extended payment terms decrease our cash flow from operations.
In addition to extended payment terms, in some cases the purchase price for our hardware products is also variable based on the number of patients treated with the product, which may make it more difficult for us to accurately forecast revenue.
Economic, political and other risks associated with international sales and operations could adversely affect our sales or make them less predictable.
Revenues outside of the United States accounted for approximately 57%, 55%, and 53% of our total revenues during fiscal years 2019, 2018 and 2017, respectively. Correspondingly, we must provide significant service and support globally. We intend to continue to expand our presence in international markets and expect to expend significant resources in doing so. We cannot assure you that we will be able to recover these investments in international markets.
Our results of operation could be adversely affected by a variety of factors, including, among other things:
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lower sales prices and gross margins usually associated with sales of our products and services in international regions, and in emerging markets in particular;
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the longer payment cycles associated with many foreign customers;
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the typically longer periods from placement of orders to revenue recognition in certain international and emerging markets;
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difficulties in interpreting or enforcing agreements and collecting receivables through the legal systems of many foreign countries;
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unstable regional political and economic conditions or changes in restrictions on trade between the United States and other countries;
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changes in the political, regulatory, safety or economic conditions in a country or region, including as a result of the pending United Kingdom (the “U.K.”) exit from the European Union (“E.U.”) (“Brexit”);
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the imposition by governments, including the United States, of additional taxes, tariffs, global economic sanctions programs or other restrictions on foreign trade;
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any inability to obtain required export or import licenses or approvals;
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any inability to comply with export or import laws and requirements or any violation of sanctions regulations, which may result in enforcement actions, civil or criminal penalties and restrictions on exportation;
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any increase in the cost of trade compliance functions to comply with changes to regulatory requirements;
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failure to obtain proper business licenses or other documentation, or to otherwise comply with local laws and requirements to conduct business in a foreign jurisdiction; and
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the possibility that it may be more difficult to protect our intellectual property in foreign countries.
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Tariffs or cross-border trade restrictions could increase the cost of our products.
Between July 2018 and May 2019, the Trump Administration imposed a series of tariffs, ranging from 5% to 25%, on numerous products imported into the United States from China, including Varian’s radiotherapy systems manufactured in China and certain components used in our manufacturing and service activities. In July and August of 2018, China retaliated against the U.S. tariffs by imposing its own series of tariffs, ranging from 10% to 25%, on certain products imported into China from the United States, including Varian’s radiotherapy systems and certain manufacturing and service components.
We participated in the Office of the U.S. Trade Representative (“USTR”) process to seek product-specific exclusions from the U.S. tariffs on Chinese imports. To date, USTR has granted tariff exclusions for four products: certain radiotherapy systems manufactured in China, as well as three key components of the radiation therapy systems that we manufacture in the United States: multi-leaf collimators, certain printed circuit board assemblies and tungsten shielding. We submitted an additional U.S. exclusion request in September 2019, in relation to a manufacturing component, which request is pending.
In June and July 2019, Varian submitted formal requests to the Chinese government for exclusions from the Chinese retaliatory tariffs for manufacturing inputs, service parts and radiotherapy systems imported into China from the United States. In September 2019, the Chinese government granted a tariff exclusion for medical linear accelerators, including our radiotherapy systems. The other exclusion requests are still pending.
The U.S. and Chinese government tariff exclusions have retroactive effect and are valid for one-year periods, with anticipated renewal processes.
These tariffs and any additional tariffs or tariff increases imposed by the United States or China that apply to our systems or component parts could increase the costs of our products and adversely impact the competitiveness of our products and/or our operational results in the future. In addition, while to date several of our exclusion requests to USTR and China have been successful, there can be no assurance that we will be successful in obtaining additional tariff exclusion requests or that any existing tariff exclusions that have been granted will be renewed. In addition, while we believe we are eligible for refunds for tariffs that have been levied following the grant of the tariff exclusions, there can be no assurance that we will ultimately receive such refunds, which could have an adverse impact on our operating results.
Changes in foreign currency exchange rates may impact our results.
Because our business is global, and payments are generally made in local currency, fluctuations in foreign currency exchange rates can impact our results by affecting product demand, or our revenues and expenses, and/or the profitability in U.S. Dollars of products and services that we sell in foreign markets.
While we use hedging strategies to help offset the effect of fluctuations in foreign currency exchange rates, the protection these strategies provide is affected by the timing of transactions, the effectiveness of the hedges, the number of transactions that are hedged and forecast accuracy. If our hedging strategies do not offset these fluctuations, our revenues, margins and other operating results may be adversely impacted. Furthermore, movements in foreign currency exchange rates could impact our financial results positively or negatively in one period and not in another, making it more difficult to compare our financial results from period to period.
In addition, our hedging program is designed to hedge currency movements on a relatively short-term basis, typically up to the next twelve-month period. Therefore, we are exposed to currency fluctuations over a longer term. Long-term movements in foreign currency exchange rates can also affect the competitiveness of our products in the local currencies of our international customers. A substantial portion of our international sales are priced in local currencies, although our cost structure is weighted towards the U.S. Dollar. Therefore, the strengthening of the U.S. Dollar may adversely affect our competitiveness and financial results, as our foreign competitors may have cost structures based in other currencies and they may be more competitive when the U.S. Dollar strengthens against those currencies.
Changes in monetary or other policies here and abroad, including as a result of economic and or political instability, or in reaction thereto, would also likely affect foreign currency exchange rates. Furthermore, if one or more European countries were to replace the Euro with another currency, our sales into these countries, or into Europe generally, would likely be adversely affected until stable exchange rates are established.
Unfavorable results of legal proceedings could adversely affect our financial results.
From time to time, we are a party to or otherwise involved in legal proceedings, claims and government inspections or investigations and other legal matters, both inside and outside the United States, including product liability claims and intellectual property claims. For example, in October 2018, Best Medical International, Inc. ("Best Medical") filed a complaint for patent infringement against us in the United States District Court for the District of Delaware alleging that several of our products infringe several of Best Medical's patents. Based on currently available information, we are unable to make a reasonable estimate of loss or range of losses, if any, arising from this matter. Legal proceedings are often lengthy, taking place over a period of years before the outcome is final. Litigation is subject to significant uncertainty and may be expensive, time-consuming, and disruptive to our operations.
If a legal proceeding were finally resolved against us, it could result in significant compensatory damages, and in certain circumstances punitive or trebled damages, disgorgement of revenue or profits, remedial corporate measures or injunctive relief imposed on us. If our existing insurance does not cover the amount or types of damages awarded, or if other resolution or actions taken as a result of the legal proceeding were to restrain our ability to market one or more of our material products or services, our consolidated financial position, results of operations or cash flows could be materially adversely affected. In addition, legal proceedings, and any adverse resolution thereof, can result in adverse publicity and damage to our reputation, which could adversely impact our business.
Consolidation among our oncology systems customers could adversely affect our sales of oncology products.
We have seen and may continue to see some consolidation among our customers in our Oncology Systems business, as hospitals and clinics combine through mergers and acquisitions, and as they join group purchasing organizations or affiliated enterprises. In addition, we have seen and may continue to see integration of equipment and information systems among hospitals as they consolidate their networks. As customers consolidate and/or integrate, the volume of product sales to these customers might decrease. Alternatively, order size may increase, as customers combine orders as one entity, or as groups of organizations combine their purchases. If orders increase in size and require more customer approvals, the purchasing cycle for our Oncology Systems products could lengthen. Both increased order size and extended purchasing cycles could cause our gross orders to be more volatile and less predictable and could result in longer overall order to revenue cycles. In addition, some customers appear to be developing new partnerships across clinical specialties to prepare for the possibility of operating in an accountable care organization (“ACO”) environment and the possibility of bundled reimbursement payments. Group purchasing organizations often focus on pricing as the determinant in making purchase decisions. A reduction in pricing could negatively impact gross orders, future revenues and gross margins.
Our business will suffer if we are unable to provide the significant education and training required for the healthcare market to accept our products.
In order to achieve market acceptance for our radiation therapy products, we often need to (i) educate physicians about the use of treatment procedures such as IMRT, IGRT, VMAT, SRS, SBRT, proton therapy or procedures using our interventional oncology products, (ii) overcome physician objections to some of the effects of the product or its related treatment regimen, (iii) convince healthcare payors that the benefits of the product and its related treatment process outweigh its costs, and (iv) help train qualified physicists in the skilled use of the product. For example, the complex and dynamic nature of IMRT and IGRT requires significant education of hospital personnel and physicians regarding the benefits of and practices associated with IMRT and IGRT. Further, the complexity and high cost of proton therapy requires similar significant education, as well as education regarding construction and facility requirements. We have devoted and will continue to devote significant resources to marketing and educational efforts to (a) create awareness of IMRT, IGRT, VMAT radiotherapy, SRS, SBRT, proton therapy or procedures using our interventional oncology products, (b) encourage the acceptance and adoption of our products for these technologies and (c) promote the safe and effective use of our products in compliance with their operating procedures. Future products may not gain adequate market acceptance among physicians, patients and healthcare payors, even if we spend significant time and expense educating them about these products.
Our business may suffer if we are not able to hire and retain qualified personnel.
Our future success depends, to a great degree, on our ability to retain, attract, expand, integrate and train our management team and other key personnel, such as qualified engineering, service, sales, marketing and other staff. We compete for key personnel with other medical equipment and software manufacturers, as well as universities and research institutions. As we continue to grow our software revenues, we face intense competition for personnel from software and technology companies. Because this competition is intense, compensation-related costs could increase significantly if the supply of qualified personnel decreases or demand increases. If we are unable to hire and train qualified personnel, we may not be able to maintain or expand our
business. In addition, some of our executive officers have had long careers at our company. If these executives retire or leave, and we are unable to locate qualified or suitable replacements in a timely manner, our business could be adversely affected.
We may not realize expected benefits from acquisitions of or investments in businesses, products or technologies, which could harm our business.
We need to grow and evolve our businesses in response to changing technologies, customer demands and competitive pressures. From time to time we may decide to execute on our strategy of becoming the global leader in multi-disciplinary, integrated cancer care solutions through the acquisition of, or investments in, businesses, products or technologies, rather than through organic development. For example, we completed five acquisitions in fiscal year 2019. Identifying suitable acquisition candidates can be difficult, time-consuming and costly, and we may not be able to identify suitable candidates or successfully complete identified acquisitions. In addition, negotiating and completing an acquisition can divert our management and key personnel from our current business operations, which could harm our business and adversely affect our financial results.
There can be no assurance that the businesses, products or technologies we acquire, or the businesses we invest in, will become profitable or remain so. It may cost us more than anticipated to commercialize acquired business product lines, as we experienced with our proton therapy systems, or require us to increase our research and development, sales and marketing or general and administrative expenses, any of which could adversely impact our results of operations. Moreover, our failure to successfully manage the growth of an acquired businesses could have an adverse impact on the overall financial performance of our business.
Factors that will affect the success of our acquisitions include:
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our ability to retain key employees of the acquired businesses;
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the performance of the acquired businesses and their technologies, products or services;
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our ability to integrate the operations, financial and other systems of the acquired businesses;
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the ability of the combined company to achieve synergies such as increasing sales of the combined company’s products and services, achieving expected cost savings and effectively combining technologies to develop new products and services;
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any disruption in order fulfillment or loss of sales due to integration processes;
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increases in our risk of litigation, as a third-party may be more likely to assert a legal claim following an acquisition because of perceived deeper pockets or perceived greater value of a claim;
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the absence of adequate internal controls and/or the presence of fraud in the acquired businesses;
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our ability to retain or grow the acquired company’s customers, suppliers, distributors or other partners;
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any decrease in customer and distributor loyalty and product orders caused by dissatisfaction with the product lines and sales and marketing practices of the acquired businesses, including price increases; and
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our assumption of known contingent liabilities, known liabilities that prove greater than anticipated, or unknown liabilities that come to light, in each case to the extent that the realization of such liabilities increases our expenses or adversely affects our business or financial position.
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When we acquire a business, we allocate the total purchase price to the acquired businesses’ tangible assets and liabilities, identifiable intangible assets and liabilities based on their fair values as of the date of the acquisition, and we record the excess of the purchase price over those fair values as goodwill. If we fail to achieve the anticipated growth or cash flows from an acquisition, or if we decide to sell assets or a business, we may be required to recognize an impairment loss on the write down of our assets and goodwill, which could adversely affect our financial results. In addition, from time to time we structure our acquisitions to include earnout provisions that require us to pay the sellers of the businesses we acquire additional cash payments upon the accomplishment of financial performance or developmental milestones in the periods following the acquisition closing date. Any changes to our estimate of the expected earnout payments after the close of the acquisition up to and including the final payment, would generally be reflected on our statement of earnings. Moreover, acquisitions can result in
potentially dilutive issuances of equity securities or the incurrence of debt, contingent liabilities or expenses, or other charges, any of which could harm our business and affect our financial results.
Additionally, we have investments in privately held companies. These investments are inherently risky, in some instances because the markets for the technologies or products these companies have under development may never materialize or achieve expectations. If these companies do not succeed, we may be forced to record impairment charges and could lose some or all of our investment in these companies.
Our efforts to integrate acquired businesses may not be successful, and this may adversely affect our financial results.
The success of business acquisitions may depend on our ability to successfully integrate the operations of the acquired business. Integrating the operations of acquired businesses requires significant efforts, including the coordination of operations, manufacturing, personnel, information technologies, research and development, sales and marketing and finance. These efforts can be compounded when the acquisitions are in new geographies or business lines. If these integration efforts are not successful, the anticipated benefits and synergies of the acquisition may not be realized fully, may take longer to realize than expected, or may not be realized at all. Our efforts to successfully integrate acquisitions may also result in additional expenses and divert significant amounts of management’s time from other projects.
Acquiring or implementing new business lines or offering new products and services may subject us to additional risks.
From time to time, we may acquire or implement new business lines or offer new products and services within existing lines of business. For example, with our June 2019 acquisition of Cancer Treatment International (“CTSI”), we entered the healthcare provider space and plan to expand into treatment planning and service, and with our July and August 2019 acquisitions of Endocare and Alicon we entered the Interventional Oncology market. There are substantial risks and uncertainties associated with these efforts. We may invest significant time and resources in developing, marketing, or acquiring new lines of business and/or offering new products and services. Initial timetables for the introduction and development or acquisition of new lines of business and/or the offering of new products or services may not be achieved, and price and profitability targets may prove to be unachievable. Our lack of experience or knowledge, as well as external factors, such as compliance with regulations, competitive alternatives and shifting market preferences, may also impact the success of an acquisition or the implementation or of a new line of business or a new product or service. Entry into a new line of business and/or offering a new product or service may also subject us to new laws and regulations with which we are not familiar and may lead to increased litigation or regulatory risk. Furthermore, any new business line and/or new product or service could have an adverse impact on the effectiveness of our system of internal controls. New business lines or new products and services within existing lines of business could affect the sales and profitability of existing lines of business or products and services, including as a result of sales channel conflicts. Other risks include: (i) potential diversion of management’s attention, available cash, and other resources from our existing businesses; (ii) unanticipated liabilities or contingencies; (iii) the need for additional capital and other resources to expand into or acquire the new line of business; (iv) potential damage to existing customer relationships, lack of customer acceptance or inability to attract new customers; and (v) the inability to compete effectively. These risks would be magnified to the extent that any new business line would result in a significant increase in operations in developing markets. Failure to successfully manage these risks in the implementation or acquisition of new lines of business or the offering of new products or services could have a material adverse effect on our reputation, business, results of operations, and financial condition.
Losing distributors may harm our revenues in some territories.
We have strategic relationships with a number of key distributors for sales and service of our products. If these strategic relationships end and are not replaced, our revenues from product sales or the ability to service our products in the territories serviced by these distributors could be adversely affected.
The results of studies and clinical trials are highly uncertain.
We have in the past conducted, and, in the future may continue to conduct, clinical trials related to prospective new therapies and technologies, including most recently pre-clinical studies in relation to ultra-high dose rate cancer treatments using our ProBeam platform. The results of preclinical studies and early clinical trials of product candidates or new therapies and technologies may not be predictive of the results of later-stage clinical trials, and favorable data from interim analyses do not ensure that the final results of a trial will be favorable. Product candidates or new therapies and technologies may fail to show the desired safety and efficacy traits despite having progressed through preclinical studies and initial clinical trials, or despite having produced favorable data in connection with an interim analysis. A number of companies in our industry have suffered significant setbacks in advanced clinical trials due to lack of efficacy or adverse safety profiles, notwithstanding promising
results in earlier trials. In addition, even if such clinical trials are successfully completed, we cannot guarantee that the FDA or comparable foreign regulatory authorities will interpret the results as we do, and more trials could be required before we submit our product candidates, new therapies or technologies for approval. To the extent that the results of trials are not satisfactory to the FDA or comparable foreign regulatory authorities for support of a marketing application or desired reimbursement classification product codes, we may be required to expend significant resources, which may not be available to us, to conduct additional trials in support of potential approval of our product candidates, new therapies or technologies.
Our credit facility restricts certain activities, and failure to comply with this agreement may adversely affect our business, liquidity and financial position.
We maintain a credit facility that contains affirmative and negative covenants that could restrict our operating and financing activities. These provisions limit our ability to, among other things, incur future indebtedness, contingent obligations or liens, guarantee indebtedness, make certain investments and capital expenditures, sell stock or assets and pay dividends, and consummate certain mergers or acquisitions. Because of the restrictions on our ability to create or assume liens, we may find it difficult to secure additional indebtedness if required.
We have in the past used borrowings under our credit facility to fund the repurchase of our shares, and we may continue to do so in the future. Furthermore, if we fail to comply with the credit facility requirements, we may be in default. Upon an event of default, if the credit agreement is not amended or the event of default is not waived, the lender could declare all amounts outstanding, together with accrued interest, to be immediately due and payable. If this happens, we may not be able to make those payments or borrow sufficient funds from alternative sources to make those payments. Even if we were to obtain additional financing, that financing may be on unfavorable terms.
Changes in the interpretation or application of generally accepted accounting principles may adversely affect our operating results.
We prepare our financial statements to conform to GAAP. These principles are subject to interpretation by the Financial Accounting Standards Board (“FASB”), the American Institute of Certified Public Accountants, the SEC and various other regulatory or accounting bodies. A change in interpretations of, or our application of, these principles can have a significant effect on our reported results and may even affect our reporting of transactions completed before a change is announced. In addition, when we are required to adopt new accounting standards, our methods of accounting for certain items may change, which could cause our results of operations to fluctuate each period. We may introduce new products or new technologies that require us to apply different accounting principles than we have applied in past periods, including accounting principles regarding revenue recognition. The application of different types of accounting principles and related potential changes may also make it more difficult to compare our financial results to prior periods, and the trading price of VMS common stock could suffer or become more volatile.
Our operations are vulnerable to interruption or loss due to natural or other disasters, power loss, strikes and other events beyond our control.
We conduct a significant portion of our activities, including manufacturing, administration and data processing at facilities located in the State of California and other seismically active areas that have experienced major earthquakes and other natural disasters. We carry limited earthquake insurance that may not be adequate or continue to be available at commercially reasonable rates and terms. In addition, we have operations in parts of the world, including cancer centers in parts of India, which have experienced natural disasters such as tsunamis, floods and drought. A major earthquake or other disaster (such as a major fire, hurricane, flood, drought, tsunami, volcanic eruption or terrorist attack) affecting our facilities, or those of our suppliers, could significantly disrupt our operations, and delay or prevent product manufacture and shipment during the time required to repair, rebuild or replace the damaged facilities. These delays could be lengthy and costly. If any of our customers’ facilities are adversely affected by a disaster, shipments of our products could be delayed. Additionally, customers may delay purchases of our products until operations return to normal or may move to a competitor that can meet their desired delivery time frame. In addition, our facilities may be subject to a shortage of available electrical power and other energy supplies. Any shortages may increase our costs for power and energy supplies or could result in blackouts, which could disrupt the operations of our affected facilities and harm our business. Further, our products are typically shipped from a limited number of ports, and any disaster, strike or other event blocking shipment from these ports could delay or prevent shipments and harm our business. In addition, concerns about terrorism, the effects of a terrorist attack, political turmoil or an outbreak of epidemic diseases could have a negative effect on our business operations, those of our suppliers and customers, and the ability to travel, resulting in adverse consequences on our revenues and financial performance.
The decision by British voters to exit the E.U. may negatively impact our operations.
In June 2016, a majority of voters in the U.K. elected to withdraw from the E.U. (often referred to as Brexit) in a national referendum. On October 17, 2019, U.K. Prime Minister Boris Johnson and the E.U. agreed to new terms for the country’s exit from the E.U., which must be approved by the British Parliament. As of the date of this filing, the British Parliament has not agreed upon the terms of the withdrawal, which was extended until January 31, 2020. The referendum and ongoing negotiations have created significant uncertainty about the future relationship between the U.K. and the E.U.
If the U.K. leaves the E.U. with no agreement, it will likely have an adverse impact on labor and trade and will create further short-term currency volatility. In the absence of a future trade deal, the U.K.’s trade with the European Union and the rest of the world would be subject to tariffs and duties set by the World Trade Organization, which could result in higher importation costs for our products. In addition, the movement of goods between the U.K. and the remaining member states of the E.U. will be subject to additional inspections and documentation checks, leading to possible delays at ports of entry and departure. Moreover, currency volatility could drive a weaker British pound, which could result in a decrease in the profitability of our U.K. operations. Any adjustments we make to our business and operations as a result of Brexit could result in significant expense and take significant time to complete.
While we have not experienced any material financial impact from Brexit on our U.K. business to date, sales into the U.K. represented approximately 3% of our total revenues in fiscal year 2019, and we cannot predict its future implications. Any impact from Brexit on our business and operations over the long term will depend, in part, on the outcome of tariff, tax treaties, trade, regulatory, and other negotiations the U.K. conducts.
We work in international locations with high security risks, which could result in harm to our employees or contractors or cause us to incur substantial costs.
We work in some international locations where there are high security risks, which could result in harm to our employees and contractors or substantial costs to maintain the safety of our personnel. Some of our services are performed in high-risk locations or adjacent locations where the country or surrounding area is suffering from political, social, or economic issues, war or civil unrest, or is experiencing a high level of criminal or terrorist activity. Despite the precautions that we take, the safety of our personnel in these locations may continue to be at risk, and we may in the future suffer the loss of employees and contractors, which could harm our business and operating results.
Product defects or misuse may result in material product liability or professional errors and omissions claims, litigation, investigation by regulatory authorities or product recalls that could harm our future financial results.
Our business exposes us to potential product liability claims that are inherent in the manufacture, sale, installation, servicing and support of medical devices and other devices that deliver radiation. Because our products are involved in the intentional delivery of radiation to the human body and other situations where people may come into contact with radiation, the possibility for significant injury and/or death exists. Our products operate within our customers’ facilities and network systems, and under quality assurance procedures established by the facility that ultimately delivers radiation to patients. Human and other errors or accidents may arise from the operation of our products in complex environments, particularly with products from other vendors, where interoperability or data sharing protocol may not be optimized even though the equipment or system operates according to specifications. In addition, if the integrity of a catheter used as part of our cryoablation system is compromised, serious injury or death may occur. As a result, we may face substantial liability to patients, our customers and others for damages resulting from the faulty, or allegedly faulty, design, manufacture, installation, servicing, support, testing or interoperability of our products with other products, or their misuse or failure. In addition, third-party service providers could fail to adequately perform their obligations, which could subject us to further liability. We may also be subject to claims for property damages or economic loss related to or resulting from any errors or defects in our products, or the installation, servicing and support of our products. Any accident or mistreatment could subject us to legal costs, litigation, adverse publicity and damage to our reputation, whether or not our products or services were a factor. In connection with our products that collect and store patient treatment data, we may be liable for the loss or misuse of such private data or personal information, if those products fail or are otherwise defective.
Product liability actions are subject to significant uncertainty and may be expensive, time-consuming, and disruptive to our operations. If a product liability action were determined against us, it could result in significant damages, including punitive damages, and our consolidated financial position, results of operations or cash flows could be materially adversely affected.
Adverse publicity regarding any accidents or mistreatments could cause patients to be less receptive to radiotherapy or radiosurgery treatments, to question the efficacy of radiation therapy and radiosurgery and to seek other methods of treatment.
Adverse publicity could also result in additional regulation that could adversely affect our ability to promote, manufacture and sell our products.
In addition, if a product we design or manufacture was defective or found to be so by a competent regulatory authority, we may be required to correct or recall the product and notify other regulatory authorities. The adverse publicity resulting from a correction or recall, however imposed, could damage our reputation and cause customers to review and potentially terminate their relationships with us. A product correction or recall could consume management time, cause us to lose new orders, cause customers to cancel or delay installation of existing orders, or cause us to incur significant costs, any of which could have an adverse effect on our results of operation.
We maintain limited product liability and healthcare professional liability insurance coverage and do not maintain errors and omissions insurance. Our product liability and healthcare professional liability insurance policies are expensive and have high deductible amounts and self-insured retentions. Our insurance coverage may be inadequate, and future policies may not be available on acceptable terms or in sufficient amounts, if at all. If a material claim is successfully brought against us, we may have to pay substantial damages if they are not covered by insurance.
We are subject to certain risks related to the separation of our former imaging components business into Varex Imaging Corporation.
On January 28, 2017, we completed the separation of our former Imaging Components business through the distribution of 100% of the outstanding common stock of Varex Imaging Corporation (“Varex”) to our stockholders. We obtained an opinion of outside counsel to the effect that the separation will qualify as a transaction that is generally tax-free to both Varian and its stockholders for United States federal income tax purposes under Sections 355 and 368(a)(1)(D) of the United States Internal Revenue Code of 1986, as amended. An opinion of outside counsel represents their legal judgment but is not binding on the Internal Revenue Service (the “IRS”) or any court. Accordingly, there can be no assurance that the IRS will not challenge the conclusions reflected in the opinion or that a court would not sustain such a challenge.
ADDITIONAL RISKS RELATING TO OUR SOFTWARE PRODUCTS
We may face delays in the installation of our software products, which could have a material adverse effect on our operating results.
We may face delays in the installation and acceptance of our software products, which may take more time from order to completion of installation and acceptance than our hardware products. Though several of our software products are cloud-enabled, many of our current software product offerings are designed as on-premise products which must be installed on customer systems on-site. Delays in installation of our software products may arise as a result of a variety of factors, including (i) longer installation timetables resulting from challenges in coordinating on-site visits with the customer personnel, (ii) customer IT systems not being ready to host the installation, or (iii) the planning and customization required to deploy our software products in order to be compatible with a customer’s unique, complex and/or dated health IT systems. Delays in installation of our software products could result in delays in our ability to recognize revenues from the sale of these products, which could have a material adverse effect on our operating results and financial performance.
The need to maintain and service multiple versions of the same software product across our installed base of customers could adversely affect our ability to release upgraded or new products.
Because there is no uniform practice among our customer base of updating to more recent versions of our software products and, for a variety of reasons, many of our customers do not regularly update to the newest version of our software products, at any point in time our installed base of customers may be running several different versions of our software products. The need to maintain and service multiple versions of the same software product across our installed base of customers can be cumbersome, time consuming and may require more personnel and other resources than would be the case if all of our customers utilized the same versions of our software products. Moreover, the fact that not all of our customers run the same version of our software products can complicate our ability to efficiently release upgrades to, or new versions of, our software products across our installed base. Similar complications to the release and installation of upgrades may be experienced with certain of our cloud-enabled products that have been developed using single tenant architecture, such as our 360 Oncology product. In addition, in many instances, unless a customer has a certain version of our software products installed, their system will not be compatible with certain of our other software or hardware products. Our inability to release new versions of software to customers or to sell customers other products because of incompatibility issues hurts our revenues and may make revenue projection less predictable.
Coding errors in our software and cloud offerings could adversely affect our results of operations.
Despite extensive testing prior to the release and throughout the lifecycle of a product or service, our software and cloud offerings sometimes contain coding or manufacturing errors that can impact their function, performance and security, and result in other negative consequences. The detection and correction of any errors in released software or cloud offerings can be time consuming and costly. Errors in our software or cloud offerings could affect their ability to properly function or operate with other software, hardware or cloud offerings, delay the development or release of new products or services or new versions of products or services, create security vulnerabilities in our products or services, and adversely affect market acceptance of our products or services. If we experience errors or delays in releasing our software or cloud offerings or new versions thereof, our sales could be affected, and revenues could decline.
We may not be successful in transitioning our customer base to software solutions deployed via cloud and SaaS solutions.
We are expanding our software product lines and investing in the development of cloud and SaaS solutions. Cloud and SaaS solutions for use in the health care industry must comply with stringent regulations in many of the countries in which our customers are located, particularly in relation to the use and storage of patient health data and privacy, and the regulations vary on a country-by-country basis. Our software products must be compliant with applicable regulation in the country in question before we can operationalize our offerings for customers located in those countries. Ensuring the compliance of our cloud and SaaS solutions with applicable regulation may take longer than expected, occur more slowly in certain countries than in others, require that design changes be developed into our products, or require more financial resources than anticipated.
In addition, even where our cloud and SaaS solutions are compliant with applicable regulation, customers may nevertheless refuse to adopt our products for numerous reasons, particularly in regards to the security of patient health data. Moreover, unless and until our cloud and SaaS solutions find general acceptance among our customer base, we would likely need to maintain and continue to develop both our on-premise software product offerings and our cloud and SaaS solution platforms, which could prevent us from realizing the full benefits and efficiencies from transitioning to a cloud platform, result in higher costs and have a material adverse effect on our operating results and financial performance.
An increase in the prevalence of cloud and SaaS delivery models offered by us and our competitors could also unfavorably impact the pricing of our on-premise software offerings and have a dampening impact on overall demand for our on-premise software product and related service offerings, which could reduce our revenues and profitability. In addition, to the extent that demand for our cloud offerings increases in the future, we may experience volatility in our reported revenues and operating results due to the differences in timing of revenue recognition between our software licenses and our cloud offering arrangements.
Furthermore, our cloud and SaaS software products may reside upon and be hosted by third party providers. A security breach, whether of our products, of our customers’ network security and systems or of third-party hosting services, could disrupt treatments utilizing our products, disrupt access to our customers’ stored information, such as patient treatment delivery instructions, and could lead to the loss of, damage to or public disclosure of our customers’ stored information, including patient health information.
Because we recognize revenue from subscriptions for our SaaS solutions over the term of the subscription, downturns or upturns in our SaaS business may not be immediately reflected in our operating results.
We recognize SaaS related revenue from customers ratably over the terms of their subscription agreements. As a result, most of the revenue we report in each quarter relating to our SaaS products is the result of subscription agreements entered into during previous quarters. Consequently, a decline in new or renewed subscriptions in any one quarter may not be reflected in our revenue results for that quarter. Any such decline, however, could negatively impact our revenue in future quarters. Accordingly, the effect of significant downturns in sales and market acceptance of our SaaS solutions, and potential changes in our attrition rate, may not be fully reflected in our results of operations until future periods.
Certain software that we use in our products is licensed from third parties and, for that reason, may not be available to us in the future, which has the potential to delay product development and production or cause us to incur additional expenses.
Some of our software products contain software licensed from third parties. Some of these licenses may not be available to us in the future on terms that are acceptable to us or allow our products to remain competitive. The loss of these third-party licenses or the inability to maintain any of them on commercially acceptable terms could delay development of future products or the enhancement of existing products. We may also choose to pay a premium price for such a license in certain circumstances, thereby reducing the gross margin of our software sales.
ADDITIONAL RISKS RELATING TO OUR PROTON SOLUTIONS BUSINESS
We participate in project financing for our Proton Solutions business, which has resulted in impairment charges and could result in payment defaults that adversely affect our financial results.
We have participated along with others in providing financing for the construction and start-up operations of several proton therapy centers and may provide financing to other proton therapy customers in the future. As of September 27, 2019, we had $165.2 million of loans outstanding, including accrued interest, available-for-sale securities, notes receivable and short-term senior secured debt related to Proton Solutions customers. See “Management Discussion and Analysis - Overview - Proton Solutions” and Note 15, "Proton Solutions Loans and Investment," of the Notes to the Consolidated Financial Statements for the carrying value of our outstanding loans relating to the establishment of proton therapy centers. Providing such financing has adversely affected and could in the future adversely affect our financial results, since a center may not be completed on time or within budget, or may not generate sufficient patient volumes and revenues to support scheduled loan payments or facilitate a refinancing. If a borrower does not have the financial means to pay off loan amounts owing to us, and if we cannot recover loan amounts owing to us from the sale of any collateral or through other means, or in the event of a bankruptcy of the borrower, we may be required to write-off all, or a portion, of the loans, which would adversely affect our financial results. For example, in fiscal year 2017, the California Proton Therapy Center, LLC (“CPTC”), to which we had project financing outstanding, filed for bankruptcy and we recorded $51.4 million in impairment charges related to that financing. We also recorded an allowance for doubtful accounts of $37.8 million related to CPTC and one other proton center in fiscal year 2017. Similarly, in fiscal year 2018, we recorded impairment charges of $22.1 million on our subordinated loans to the Maryland Proton Therapy Center (“MPTC”). Please refer to “Management Discussion and Analysis - Overview - Varian Proton Solutions” and Note 15, "Proton Solutions Loans and Investment," of the Notes to the Consolidated Financial Statements for a more detailed discussion of the impairment of the loan we extended. Any impairment charges relating to our Proton Solutions business could have a material adverse impact our operating results and financial position.
The financial results of our Proton Solutions business may be unpredictable and if our proton customers are unsuccessful, our financial results will be adversely affected.
The success of our Proton Solutions business will depend upon the widespread awareness, acceptance and adoption by the oncology market of proton therapy systems for the treatment of cancer. This technology is expensive and has not been widely adopted. Future developments may not be adopted as quickly as technological developments in more traditional areas of radiation therapy.
Since proton therapy projects are generally large, highly customized and more complex than projects in our Oncology Systems radiotherapy business, planning for these projects takes more resources. Many of the components used in proton therapy equipment require long lead times, which may require an increase in our inventory levels. This may cause fluctuations in the operating results of Proton Solutions that may make it difficult to predict our results and compare our results from period to period.
The construction of a proton therapy facility requires significant capital investment and may involve complex project financing. Consequently, this business is vulnerable to deterioration in general economic and market conditions. Economic downturns that result in a contraction in credit markets, have made and may continue to make it more difficult for potential customers of this business to find appropriate financing for large proton therapy projects, which could cause them to delay or cancel their projects, or request payment concessions in their agreements with us, which could adversely impact our operating results.
Proton therapy is expensive and changes in reimbursement rates for proton therapy treatments or uncertainty regarding these reimbursement rates can affect growth or demand for our Proton Solutions products and services.
After a proton therapy facility is established, there can be no assurance that it will have sufficient patient volume to be successful or profitable. If a proton treatment center cannot generate sufficient patient volume, it may lead to a need to refinance or renegotiate debt, seek concession on payments, or ultimately insolvency and bankruptcy, as in the case of CPTC and the Rinecker Proton Therapy Center in Germany, which has and may in the future require us to impair loans if we have extended loans to the proton treatment center, or to record an allowance for doubtful accounts against accounts receivables due from the proton treatment center.
Our estimates as to future operating results include certain assumptions about the future results of Proton Solutions’ business. If we are incorrect in our assumptions, our financial results could be materially and adversely affected. It is possible that Proton Solutions could perform significantly below our expectations due to a number of factors that cannot be predicted with certainty,
including future market conditions, market acceptance of proton therapy and reimbursement rates. These factors could adversely impact Proton Solutions' ability to meet its projected results. For example, during the third quarter of fiscal year 2019, we recorded a goodwill charge of $50.5 million for the full value of the Proton Solutions reporting unit goodwill, which resulted from a downward revision of forecasted future cash flows attributable to continued weakness in proton therapy markets and lower than expected results as compared to prior forecasts.
We compete for many proton therapy system sales through tenders, where parties compete on price and other factors. Many companies sell their products at a lower price than we do. If we are unable to lower our prices or our customers are not willing to pay for additional features and functionality that we may provide, we may lose sales, and if we lower our prices to gain business, our margins and other financial results may suffer. Further, the award of certain proton therapy system orders may be subject to challenge by third parties, which can make these orders more unpredictable than orders for other products. Because an order for a proton therapy system can be large and complex, and the sales cycle for proton therapy projects may take several years, an order in one fiscal period may cause our gross orders and revenues to vary significantly, making it difficult to predict and compare our results of operations from period to period.
We expect that a limited number of customers will account for a substantial portion of Proton Solutions' business for the foreseeable future. In instances where one customer undertakes multiple proton center projects, an adverse event with respect to one project could cause an adverse event with respect to the other projects, which in turn could adversely impact our operating results and financial position.
Our Proton Solutions business may subject us to increased liability.
Our Proton Solutions' business may subject us to increased liability. For example, because proton therapy projects are large in scale and require detailed project planning, failure to deliver or delays in delivering on our commitments could result in greater than expected liabilities, as we could be required to indemnify business partners and customers for losses suffered or incurred if we are unable to deliver our products in accordance with the terms of customer contracts. Additionally, customers have in the past requested and may in the future request that the systems vendor, as the primary technology provider, provide guarantees for and suffer penalties in relation to the overall construction project. Since the cost of a proton therapy center project can often exceed $100 million, the amount of potential liability and potential for financial loss would likely be higher than the levels historically assumed by us for our traditional radiation therapy business and may also exceed the project’s value. Insurance covering these contingencies may be unobtainable or expensive. If we cannot reasonably mitigate or eliminate these contingencies or risks, our ability to competitively bid upon proton center projects will be negatively impacted or we may be required to assume material amounts of potential liability, all of which may have adverse consequences to us.
ADDITIONAL RISKS RELATED TO OUR CANCER TREATMENT SERVICES INTERNATIONAL BUSINESS
In June 2019, we acquired CTSI, which through its America Oncology Institute (“AOI”) business operates nine multi-disciplinary cancer centers and one specialty hospital in India, and one multi-disciplinary cancer center in Sri Lanka, as of September 27, 2019 (collectively, “cancer centers”). CTSI also operates AmPath, a full-service reference laboratory and pathology provider in India. Our AOI and AmPath businesses subject us to a number of risks, including those set forth below.
Our cancer center operations may not be profitable, and the operation or development of existing and future cancer centers could cause us to incur unexpected costs.
The operation and development of cancer centers is subject to a number of risks, including the inability to obtain regulatory permits or approval, delays in the construction of facilities and environmental liabilities related to the disposal of radioactive, chemical and medical waste. Our strategy includes the development of additional multidisciplinary cancer centers, and we have several cancer centers under construction and several others in various planning stages. Any failure or delay in successfully building new cancer centers, as well as liabilities from ongoing operations, could seriously harm our operating results. New cancer centers may incur significant operating losses during their initial operations, which could materially and adversely affect our operating results, cash flows and financial condition. In addition, in some cases our cancer centers may not be profitable enough for us to recover our investment. We may decide to close or sell cancer centers, either because of underperformance or other market developments.
Our performance depends on our ability to recruit and retain quality physicians, qualified nurses and medical support staff and we face competition for staffing that may increase our labor costs and harm our results of operations.
Typically, physicians are responsible for making admissions decisions and for directing the course of patient treatment at the cancer centers that we operate. As a result, the success and competitive advantage of our cancer centers may depend, in part, on
the number and quality of the physicians and the medical staffs of our cancer centers, the admitting practices of those physicians and our maintenance of good relations with those physicians. In many cases, physicians are not employees of our cancer centers, and, in a number of the regions in which we operate, physicians have admitting privileges at other cancer centers or hospitals in addition to our cancer centers. They may terminate their affiliation with us at any time. If we are unable to provide adequate support personnel and technologically advanced equipment and facilities that meet the needs of those physicians, they may be discouraged from treating patients at our facilities and our results of operations may decline.
In addition, we depend on the efforts, abilities, and experience of our medical support personnel, including our nurses, pharmacists and lab technicians and other healthcare professionals. We compete with other healthcare providers in recruiting and retaining qualified management, nurses and other medical personnel. There is a nationwide shortage of nurses and other medical support personnel in India which from time to time may require us to enhance wages and benefits in order to recruit and retain nurses and other medical support personnel or require us to hire expensive temporary personnel. To the extent we cannot hire adequate numbers of medical support personnel, we may be required to limit the healthcare services provided in these markets, which would have a corresponding adverse effect on our results of operation.
We cannot predict the degree to which we will be affected by the future availability or cost of attracting and retaining talented medical support staff. If our general labor and related expenses increase, we may not be able to raise our rates correspondingly. Our failure to recruit and retain qualified management, nurses and other medical support personnel, or control our labor costs could harm our results of operations.
Our cancer centers face competition for patients from other cancer centers, hospitals and health care providers.
The healthcare industry in India is highly competitive and competition among cancer centers, hospitals and other healthcare providers for patients and physicians has intensified in recent years. In all the geographical areas in which we operate, there are other cancer centers or hospitals that provide services comparable to those offered by our facilities. We also face competition from specialty hospitals (some of which are physician-owned) and unaffiliated freestanding outpatient centers for market share in high margin services and for quality physicians and personnel. In recent years, the number of freestanding specialty hospitals, surgery centers, emergency departments, urgent care centers and diagnostic imaging centers in the geographic areas in which we operate has increased significantly. Furthermore, some of the hospitals that compete with our hospitals are owned by government agencies or not-for-profit organizations supported by endowments and charitable contributions and can finance capital expenditures and operations on a tax-exempt basis. If our competitors are better able to attract patients, recruit physicians, expand services or obtain favorable managed care contracts at their facilities than we are, we may experience an overall decline in patient volumes.
We are subject to occupational health, safety and other similar regulations and failure to comply with such regulations could harm our business and results of operations.
Our CTSI operations in India are subject to a wide variety of Indian national and local occupational health and safety laws and regulations. Regulatory requirements affecting us include, but are not limited to, those covering: (i) air and water quality control; (ii) occupational health and safety (e.g., standards regarding blood-borne pathogens and ergonomics, etc.); (iii) waste management; (iv) the handling of asbestos, polychlorinated biphenyls and radioactive substances; and (v) other hazardous materials. If we fail to comply with those standards, we may be subject to sanctions and penalties that could harm our business and results of operations.
We may be subject to liabilities from claims brought against our cancer centers and third-party customers of our AmPath business.
We are subject to medical malpractice lawsuits, class action lawsuits and other legal actions against our cancer centers and third-party customers of our AmPath business in the ordinary course of business. Some of these actions may involve large claims, as well as significant defense costs. We cannot predict the outcome of these lawsuits or the effect that such lawsuits may have on us. In an effort to resolve one or more of these matters, we may choose to negotiate a settlement. Amounts we pay to settle any of these matters may be material. We maintain limited healthcare professional liability insurance coverage and do not maintain errors and omissions insurance. Our insurance coverage may be inadequate, and future policies may not be available on acceptable terms or in sufficient amounts, if at all. If a material claim is successfully brought against us, we may have to pay substantial damages if they are not covered by insurance, which could have a material adverse effect on our operations.
RISKS RELATING TO THE MANUFACTURE OF OUR PRODUCTS
Any inability to obtain supplies of important components could restrict the manufacture of products, cause delays in delivery, or significantly increase our costs.
We obtain some of the components included in our products from a limited group of suppliers or from a single source supplier, such as the radioactive sources for high dose rate brachytherapy, klystrons for linear accelerators and specialized integrated circuits and various other components; radiofrequency components, magnets, patient positioning systems and gantry hardware for proton therapy systems, and vacuum sleeves for our cryoablation products.
If we lose any of these suppliers, if their operations were substantially interrupted, or if any of them failed to meet performance or quality specifications, we may be required to obtain and qualify one or more replacement suppliers. Such an event may then also require us to redesign or modify our products to incorporate new parts and/or further require us to obtain clearance, qualification or certification of these products by the FDA or obtain other applicable regulatory approvals in other countries. Events like these could significantly increase costs for the affected product and likely cause material delays in delivery of our products, which could have an adverse effect on our revenue and results of operations.
Some of our single-source suppliers provide components for some of our growing product lines. Manufacturing capacity limitations of any of our suppliers or other inability of these suppliers to meet increasing demand could adversely affect us, resulting in curtailed growth opportunities for our affected product lines. Shortage of, and greater demand for, components and subassemblies could also increase manufacturing costs if the supply/demand imbalance increases the price of the components and subassemblies. Disruptions or loss of any of our limited-sourced or sole-sourced components or subassemblies or the capacity limitations of the suppliers for these components or subassemblies could adversely affect our business and financial results and could damage our customer relationships.
In addition, following the separation of our former Imaging Components business into Varex in January 2017, Varex is the sole source supplier of tubes, panels and detector components used in certain of our products, such as our On-Board Imager. Any disruption or reduction in the supply of these components could result in delays or reductions in our product deliveries, which could adversely affect our business and financial results and could damage our customer relationships. Also, any unforecasted increases in the price of these components could adversely impact our profitability.
A shortage or change in source of raw materials could restrict our ability to manufacture products, cause delays, or significantly increase our cost of goods.
We rely upon the supplies of certain raw materials such as tungsten, lead, iridium and copper for Oncology Systems and high-grade steel, high-grade copper and iron for Proton Solutions. Worldwide demand, availability and pricing of these raw materials have been volatile, and we expect that availability and pricing will continue to fluctuate in the future. If supplies are restricted or become unavailable or if prices increase, this could constrain our manufacturing of affected products, reduce our profit margins or otherwise adversely affect our business.
Pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC has promulgated rules regarding disclosure of the presence in a company’s products of certain metals, known as “conflict minerals,” which are metals mined from the Democratic Republic of the Congo and adjoining countries, as well as procedures regarding a manufacturer’s efforts to identify the sourcing of those minerals from this region. Complying with these rules requires investigative efforts, which has and will continue to cause us to incur associated costs, and could adversely affect the sourcing, supply, and pricing of materials used in our products, or result in process or manufacturing modifications, all of which could adversely affect our results of operations.
Our financial results may suffer if we are not able to match our manufacturing capacity with demand for our products.
Many of our products have a long production cycle, and we need to anticipate demand for our products in order to ensure adequate manufacturing or testing capacity. If we are unable to anticipate demand and our manufacturing or testing capacity does not keep pace with product demand, we will not be able to fulfill orders in a timely manner, which may negatively impact our financial results and overall business. Conversely, if demand for our products decreases, the fixed costs associated with excess manufacturing capacity may harm our financial results.
We rely on third parties to perform spare parts shipping and other logistics functions on our behalf. Disruptions at our logistics providers may adversely impact our business.
Third-party logistics providers store a significant portion of our spare parts inventory in depots around the world and perform a significant portion of our spare parts logistics and shipping activities. If any of our logistics providers terminates its relationship with us, suffers an interruption in its business, or experiences delays, disruptions or quality control problems in its operations, or if we have to change and qualify alternative logistics providers for our spare parts, shipments of spare parts to our customers may be delayed and our reputation, business, financial condition and results of operations may be adversely affected.
RISKS RELATING TO OUR REGULATORY ENVIRONMENT
We operate in a highly regulated industry, and we face significant costs in complying with laws and regulations. Failure or delays in obtaining regulatory approvals or complying with laws and regulations could delay or prevent product distribution, the introduction of new products or services and result in significant fines and penalties.
We operate in a highly regulated industry and our products and services are subject to numerous U.S. and foreign laws and regulations, as discussed in “Part 1, Item 1. Business - Government Regulation.” Our products, services and operations are subject to regulation by the FDA, the state of California and other U.S. states, the Nuclear Regulatory Commission ("NRC”) and regulatory bodies in the countries and regions in which we market our products and services. For example, we must comply with FDA medical device clearance and reporting regulations, and similar laws in numerous foreign countries, including the European Union (“EU”), the European Economic Area (“EEA”), Switzerland, China, Japan and Canada; and we must comply with NRC clearance, approval and licensing requirements and other federal, state and foreign laws that regulate the use of radioactive materials. We are also subject to laws and regulations in India and Sri Lanka in relation to the operation of healthcare establishments. Compliance with these regulations can be costly, time consuming and burdensome, may negatively impact our ability to market our products and services or result in significant delays or even prevent the marketing and full commercialization of future products or services. Moreover, failure to obtain regulatory approvals or renewals in a timely manner could subject us to fines and penalties.
As a participant in the healthcare industry, we are also subject to federal, state and foreign laws and regulations pertaining to fraud and abuse, physician payment transparency, false claims and misleading advertisements. These laws and regulations and their enforcement are constantly undergoing change, and we cannot predict what effect, if any, changes to these laws and regulations may have on our business or the businesses of our customers. Non-compliance with “anti-kickback”, “false claims” and transparency laws and regulations can result in substantial civil and criminal penalties and potential mandatory or discretionary exclusion from healthcare programs.
We are also subject to laws and regulations related to the collection, processing, storage, transfer and use of personal data, including under the EU General Data Protection Regulation ("GDPR") and data protection legislation in other foreign jurisdictions and the California Consumer Privacy Act of 2018 (“CCPA”) and similar laws in the United States, at both the federal and state level. The compliance and other burdens imposed by the GDPR, CCPA and similar privacy laws and regulations may limit the use and adoption of our services, reduce overall demand for our services, require us to modify our data handling practices, slow the pace at which we close sales transactions and impose additional costs and burdens. In particular, the collection, storage, transfer and use of patient information and data obtained through our AOI business operations is highly regulated by applicable law. In addition, non-compliance could result in proceedings against us by governmental entities or others and/or significant fines, could negatively impact our reputation, and may otherwise adversely impact our business, financial condition and operating results.
As we enter new businesses or pursue new business opportunities that require clinical trials, we may seek to conduct clinical studies or trials in the United States or other countries on products that have not yet been cleared or approved for a particular indication. Additional regulations govern the approval, initiation, conduct, monitoring, documentation and reporting of clinical studies to regulatory agencies in the countries or regions in which they are conducted. Failure to comply with all regulations governing such studies could subject us to significant enforcement actions and sanctions, including halting of the study, seizure of investigational devices or data, sanctions against investigators, civil or criminal penalties, and other actions. In addition, without the data from one or more clinical studies, it may not be possible for us to secure the data necessary to support certain regulatory submissions, to secure reimbursement or demonstrate other requirements. We cannot assure you that access to clinical investigators, sites and subjects, documentation and data will be available on the terms and timeframes necessary.
Any failure or delay in complying with one or more of the regulatory requirements we face could result in reduced sales, increased costs, delays to new product introductions, enhancements or our strategic plans, or harm to our reputation or competitiveness, all of which could have a material adverse effect on our business and financial results.
The Affordable Care Act includes provisions that may adversely affect our business, including an excise tax on the sales of most medical devices.
The Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act (collectively, the “ACA”) became effective in 2010. The ACA could adversely impact the demand for our products and services, and therefore our financial position and results of operations, possibly materially. Specifically, one of the components of the ACA is a 2.3% excise tax on sales of most medical devices, which include our Oncology Systems and Proton Solutions products, which took effect on January 1, 2013. In January 2018, President Trump signed into law a spending package that included a two-year moratorium on the medical device excise tax starting January 1, 2018 and ending December 31, 2019. This tax has had, and may continue to have, a negative impact on our gross margin when the moratorium expires.
In addition, discussions relating to the ACA have included the possibility for bundled reimbursement payments and ACOs. ACOs and bundled payment programs were established by the ACA to reward integrated, efficient care and allow providers to share in any savings they achieve through the coordination of care and meeting certain mandated quality standards. ACOs and the bundled payment programs have primarily focused on primary care. However, some customers appear to be developing new partnerships across clinical specialties to prepare for the possibility of operating in an ACO environment and bundled reimbursement payments. These and other elements of the ACA, including comparative effectiveness research, an independent payment advisory board, payment system reforms (including shared savings pilots) and the reporting of certain payments by us to healthcare professionals and hospitals, could meaningfully change the way healthcare is developed and delivered, and may materially impact numerous aspects of our business, including the demand and availability of our products, the reimbursement available for our products from governmental and third-party payors, and medical procedure volumes. We believe that growth of the radiation oncology market, which includes both traditional radiation therapy as well as proton therapy in the United States could be adversely impacted as customers’ decision-making processes are complicated by the uncertainties surrounding the implementation of the ACA and reimbursement rates for radiotherapy and radiosurgery, and that this uncertainty will likely continue into the next fiscal year and could result in a high degree of variability of gross orders and revenues from quarter-to-quarter.
Various healthcare reform proposals have also emerged at the state level, and we are unable to predict which, if any of these proposals will be enacted. We are also unable to predict what effect ongoing uncertainty surrounding federal and state health reform proposals, uncertainty related to implementation of ACA provisions, and instability within insurance markets created under the ACA, will have on our customer’s purchasing decisions. However, an expansion in government’s role in the United States healthcare industry may adversely affect our business, possibly materially. In addition, it is possible that changes in administration and policy, including the potential repeal of all or parts of the ACA could result in additional proposals and/or changes to health care system legislation which could have a material adverse effect on our business. The full effect that a full or partial repeal of the ACA would have on our business remains unclear at this time.
More recently, President Trump has signed an executive order and made statements that suggest he plans to seek repeal of all or portions of the ACA, and has asked Congress to replace the current legislation with new legislation. There is uncertainty with respect to the impact President Trump’s administration may have, if any, and any changes likely will take time to unfold, and could have an impact on coverage and reimbursement for healthcare items and services covered by plans that were authorized by the ACA. However, we cannot predict the ultimate content, timing or effect of any healthcare reform legislation or the impact of potential legislation on us.
Changes to radiation oncology, reimbursements, and insurance deductibles and administration may affect demand for our products and could have a material adverse effect on our results of operations, financial position and stock price.
Sales of our healthcare products indirectly depend on whether adequate reimbursement is available to our customers from a variety of sources, such as government healthcare insurance programs, including the Medicare and Medicaid programs; private insurance plans; health maintenance organizations; and preferred provider organizations. In general, employers and third-party payors in the United States have become increasingly cost-conscious, with higher deductibles imposed or encouraged in many medical plans. The imposition of higher deductibles tends to inhibit individuals from seeking the same level of medical treatments as they might seek if the costs were lower. Third-party payors have also increased utilization controls related to the use of our products by healthcare providers.
There is no uniform policy on reimbursement among third-party payors, and we cannot be sure that third-party payors will reimburse our customers at a level that will enable us to achieve or maintain adequate sales and price levels for our products. Without adequate support from third-party payors, the market for our products may be limited.
Once Medicare makes a decision to provide reimbursement for a given treatment, these reimbursement rates are generally reviewed and adjusted by Medicare annually. Private third-party payors, although independent from Medicare, sometimes use portions of Medicare reimbursement policies and payment amounts in making their own reimbursement decisions. As a result, decisions by the Centers for Medicare and Medicaid Services ("CMS") to reimburse for a treatment, or changes to Medicare’s reimbursement policies or reductions in payment amounts may extend to third-party payor reimbursement policies and amounts
for that treatment. We have seen our customers’ decision-making process complicated by the uncertainty surrounding Medicare reimbursement rates and coverage for modalities and indications for radiotherapy and radiosurgery in the United States.
From time to time, CMS and third-party payors may review and modify the factors upon which they rely to determine appropriate levels of reimbursement and coverage of procedures for cancer treatments. For example, CMS and third-party payors have begun to focus on the comparative effectiveness of radiation therapy versus other methods of cancer treatment, including surgery, and could modify reimbursement rates based on the results of comparative effectiveness studies. In addition, in July 2019, CMS announced a proposed alternative payment model (or “APM”) pilot program for radiation oncology intended to test whether an episode-based payment structure across a cohort of U.S. hospitals and freestanding cancer centers would reduce Medicare expenditures, while preserving or enhancing the quality of care. We expect that CMS will announce the APM rules in late 2019, although the exact timing and details of the APM are uncertain. Any significant cuts in reimbursement rates or changes in reimbursement methodology or administration for radiotherapy, radiosurgery, proton therapy or brachytherapy, as a result of APM or otherwise, or concerns or proposals regarding further cuts or changes in methodology or administration, could further increase uncertainty, influence our customers’ decisions, reduce demand for our products, cause customers to cancel orders, make it more difficult for us to collect payments on outstanding accounts receivable or indebtedness from our proton therapy center customers or debtors, all of which could have a material adverse effect on our results of operations, financial position and stock price.
Foreign governments also have their own healthcare reimbursement systems and there can be no assurance that adequate reimbursement will be made available with respect to our products under any foreign reimbursement system.
Any violation of federal, state or foreign laws governing our business practices may result in substantial penalties. Investigation into our business practices could cause adverse publicity and harm our business.
Anti-corruption laws and regulations. We are subject to the United States Foreign Corrupt Practices Act and anti-corruption laws, and similar laws in foreign countries, such as the U.K. Bribery Act of 2010, and the Law “On the Fundamentals of Health Protection in the Russian Federation.” Any violation of these laws by us or our agents or distributors could create a substantial liability for us, subject our officers and directors to personal liability and also cause a loss of reputation in the market. Transparency International’s 2016 Corruption Perceptions Index found that approximately sixty-nine percent of the countries in the index, including many that we consider to be high growth areas for our products, such as China, India, Russia and Brazil, scored below 50, on a scale from 100 (very clean) to 0 (highly corrupt). We currently operate in many countries where the public sector is perceived as being more or highly corrupt. Our strategic business plans include expanding our business in regions and countries that are rated as higher risk for corruption activity by Transparency International. Moreover, our recent acquisitions of CTSI and Alicon have significantly increased our operations in India and China, respectively. Increased business in higher risk countries could subject us and our officers and directors to increased scrutiny and increased liability.
In addition, we have conducted, and in the future expect to conduct internal investigations or face audits or investigations by one or more domestic or foreign government agencies. Any such investigation or proceeding results in costs and management distraction, which could adversely affect our business and financial results. An adverse outcome under any such proceeding, investigation or audit could subject us to fines, or criminal or other penalties, which could adversely affect our business and financial results.
Competition laws. We are subject to competition laws in the regions where we do business. Regulatory authorities under whose laws we operate may have enforcement powers that can subject us to sanctions and can impose changes or conditions in the way we conduct our business. In addition, an increasing number of jurisdictions provide private rights of action for competitors or consumers to seek damages asserting claims of anti-competitive conduct. Increased government scrutiny of our actions or enforcement or private rights of action could adversely affect our business or damage our reputation. In addition, we have conducted, and in the future expect to conduct, internal investigations or face audits or investigations by one or more domestic or foreign government agencies, which could be costly and time-consuming, and could divert our management and key personnel from our business operations. An adverse outcome under any such investigation or audit could subject us to fines or criminal or other penalties, which could adversely affect our business and financial results.
Environmental laws impose compliance costs on our business and can result in liability.
We are subject to environmental laws around the world. These laws regulate many aspects of our operations, including our handling, storage, transport and disposal of hazardous materials. They can also impose cleanup liabilities, including with respect to discontinued operations. As a consequence, we can incur significant environmental costs and liabilities, some recurring and others not recurring. Although we follow procedures intended to comply with existing environmental laws, we,
like other businesses, can never completely eliminate the risk of contamination or injury from certain materials that we use in our business and, therefore, the prospect of resulting claims and damage payments. We may also be assessed fines or penalties for failure to comply with environmental laws and regulations. Although insurance has provided coverage for portions of cleanup costs resulting from historical occurrences, we maintain only limited insurance coverage for costs or claims that might result from any future contamination.
Future changes in environmental laws could also increase our costs of doing business, perhaps significantly. Several countries, including some in the EU, now require medical equipment manufacturers to bear certain disposal costs of products at the end of the product’s useful life, increasing our costs. The EU has also adopted directives that may lead to restrictions on the use of certain hazardous substances or other regulated substances in some of our products sold there. These directives, along with another that requires substance information to be provided upon request, could increase our operating costs in order to maintain access to certain markets. All of these costs, and any future violations or liabilities under environmental laws or regulations, could have a material adverse effect on our business.
RISKS RELATING TO OUR INTELLECTUAL PROPERTY
Protecting our intellectual property can be costly and we may not be able to maintain licensed rights, which would harm our business.
We file applications for patents covering new products and manufacturing processes. We cannot assure you that our current patents, the claims allowed under our current patents, or the patents for technologies licensed to us will be sufficiently broad to protect our technology position against competitors. Issued patents owned by, or licensed to, us may be challenged, invalidated or circumvented, or the rights granted under the patents may not provide us with competitive advantages. We also cannot be sure that patents will be issued from any of our pending or future patent applications. Asserting our patent rights against others in litigation or other legal proceedings is costly and diverts resources. An unfavorable outcome in such litigation or proceedings could harm us. In addition, we may not be able to detect patent infringement by others or may lose our competitive position in the market before we are able to do so. Our efforts to protect our intellectual property do not prevent competitors from independently developing similar or alternative technologies or products that are equal or superior to our technology and products without infringing any of our intellectual property rights, or from designing around our proprietary technologies, which could harm us. In addition, the regulations of certain foreign countries may not protect our intellectual property rights to the same extent as the laws of the United States.
In addition to patents, we also rely on a combination of copyright, trade secret, trademark and other laws, and contractual restrictions on disclosure, copying and transferring title (including confidentiality agreements with vendors, strategic partners, co-developers, employees, consultants and other third parties), to protect our proprietary and other confidential rights. These protections may prove inadequate, since agreements may still be breached, and we may not have adequate remedies for a breach, and our trade secrets may otherwise become known to or be independently developed by others. In the event that our proprietary or confidential information is misappropriated, our business and financial results could be adversely impacted. We have trademarks, both registered and unregistered, that are maintained and enforced to provide customer recognition for our products in the marketplace, but unauthorized third parties may still use them. We also have agreements with third parties that license to us certain patented or proprietary technologies. In some cases, products with substantial revenues may depend on these license rights. If we were to lose the rights to license these technologies, or our costs to license these technologies were to materially increase, our business would suffer.
Third parties may claim we are infringing their intellectual property, and we could suffer significant litigation or licensing expenses or be prevented from selling our products.
There is a substantial amount of litigation over patent and other intellectual property rights in the industries in which we compete. Our competitors, like companies in many high technology businesses, continually review other companies’ activities for possible conflicts with their own intellectual property rights. In addition, non-practicing entities may review our activities for conflicts with their patent rights. Determining whether a product infringes a third party’s intellectual property rights involves complex legal and factual issues, and the outcome of this type of litigation is uncertain. Third parties may claim that we are infringing their intellectual property rights. We may not be aware of the intellectual property rights of others that relate to our products, services or technologies. From time to time, we receive notices from third parties asserting infringement and we are subject to lawsuits alleging infringement of third-party patent or other intellectual property rights. Any dispute regarding patents or other intellectual property could be costly and time-consuming and could divert our management and key personnel from our business operations. We may not prevail in a dispute. We do not maintain insurance for intellectual property infringement, so costs of defense, whether or not we are successful in defending an infringement claim, will be borne by us and could be significant. If we are unsuccessful in defending or appealing an infringement claim, we may be subject to significant
damages and our consolidated financial position, results of operations or cash flows could be materially adversely affected. We may also be subject to injunctions against development and sale of our products, the effect of which could be to materially reduce our revenues.
RISKS RELATING TO OUR COMMON STOCK
Fluctuations in our operating results, including quarterly gross orders, revenues, margins, and cash flows may cause our stock price to be volatile, resulting in losses for our stockholders.
We have experienced and expect to experience periodic fluctuations in our operating results, including gross orders, revenues, margins and cash flows. Drivers of orders include the introduction and timing of announcement of new products or product enhancements by us and our competitors, as well as changes or anticipated changes in third-party reimbursement amounts or policies applicable to treatments using our products. The availability of economic stimulus packages or other government funding, or reductions thereof, may also affect timing of customer purchases. Many of our products require significant capital expenditures by our customers. Accordingly, individual product orders can be quite large in dollar amounts, which can extend the customer purchasing cycle. We have experienced this with our IGRT products, and it is especially true with our proton therapy products because of the high cost of the proton therapy equipment and the complexity of project financing. In addition, the budgeting cycles of hospitals and clinics for capital equipment purchases are frequently fixed well in advance. Economic uncertainty also tends to extend the purchasing cycle as potential customers more closely scrutinize and prioritize their capital spending budgets and analyze appropriate financing alternatives. In addition, some of our more sophisticated equipment, such as IGRT and proton therapy products, requires greater site preparation and longer construction cycles, which can delay customer decision cycles and the placement of orders even further. The timing of order placement, equipment installation and revenue recognition affect our quarterly results.
Once orders are received and booked into backlog, factors that may affect whether these orders become revenue (or are cancelled or deemed dormant and reflected as a reduction in the backlog amounts) and the timing of revenue include:
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delay in shipment due (e.g. an unanticipated construction delay at a customer location where our products are to be installed), cancellations or rescheduling by customers, extreme weather conditions, natural disasters, port strikes or other labor actions;
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•a challenge to a bid award for one or more of our products;
•delay in the installation and/or acceptance of a product;
•failure to satisfy contingencies associated with an order;
•the method of accounting used to recognize revenue;
•a change in a customer’s financial condition or ability to obtain financing; or
•timing of necessary regulatory approvals or authorizations.
Our operating results, including our margins, may also be affected by a number of other factors, many of which are out of our control, including, among other things:
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changes in our or our competitors’ pricing or discount levels;
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imposition of tariffs on our products or components and services used in our products;
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negative publicity about our products and services;
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impairment of loans, notes receivables, accounts receivable;
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•changes in foreign currency exchange rates;
•changes in the relative mix between higher margin and lower margin products;
•changes in the relative portion of our revenues represented by different geographic regions;
•fluctuation in our effective tax rate, which may or may not be known to us in advance;
•changes to our organizational structure, which may result in restructuring or other charges;
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disruptions in the supply or changes in the costs of raw materials, labor, product components or transportation services;
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disruptions in our operations, including our ability to manufacture products, caused by events such as earthquakes, fires, floods, terrorist attacks or the outbreak of epidemic diseases;
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the unfavorable outcome of any litigation or administrative proceeding or inquiry, as well as ongoing costs associated with legal proceedings; and
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accounting changes and adoption of new accounting pronouncements.
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Because many of our operating expenses are based on anticipated capacity levels and a high percentage of these expenses are fixed for the short term, a small variation in the timing of revenue recognition can cause significant variations in operating results from quarter to quarter. Our overall gross margin may also be impacted by the gross margin of our proton therapy products, which presently carry lower gross margins than do our traditional radiotherapy products. If our gross margins fall below the expectation of securities analysts and investors, the trading price of VMS common stock would likely decline.
We report our gross orders and backlog on a quarterly and annual basis. It is important to understand that, unlike revenues, gross orders and backlog are not governed by GAAP, and are not within the scope of the quarterly review or annual audit conducted by our independent registered public accounting firm; therefore, investors should not interpret our gross orders or backlog in such a manner. Also, for the reasons set forth above, our gross orders and backlog cannot necessarily be relied upon as accurate predictors of future revenues. Order cancellation or delays in delivery dates will reduce our backlog and future revenues, and we cannot predict if or when orders will mature into revenues. Particularly high levels of cancellations in one period will make it difficult to compare our operating results for other periods.
In addition, our gross orders, backlog, revenues and net earnings in one or more future periods may fall below the expectations of securities analysts and investors. In that event, the trading price of VMS common stock would almost certainly decline.