VAREX IMAGING CORPORATION The following discussion and analysis contains forward-looking statements relating to future events or our future financial or operating performance that involve risks and uncertainties, as set forth above under "Forward-Looking Statements." Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors described in this Annual Report on Form 10-K.
Our Business
Varex Imaging Corporation is a leading innovator, designer and manufacturer of X-ray tubes, digital detectors, linear accelerators and other image software processing solutions, which are critical components of a variety of X-ray based imaging equipment. Our success depends, among other things, on our ability to anticipate and respond to changes in our markets, the direction of technological innovation and the demands of our customers. For additional information on our business, see Part I, Item 1.
Impact of COVID-19 and the General Economic Environment
The unprecedented nature of the COVID-19 pandemic and its effect on the global economy began to significantly disrupt our business in fiscal year 2020 by initially reducing demand for our products followed by strong recovery in demand but increasing variability in supply of raw materials and manufacturing productivity. During the twelve months endedOctober 1, 2021 , demand for many of our products recovered to pre-pandemic levels and our business has continued to grow. We believe that demand for our products has increased due to increased investments in healthcare and diagnostics coupled with end-users (such as hospitals) making capital purchases that were previously deferred due to the uncertainty surrounding COVID-19. While we are encouraged by the recovery that we have seen, we remain cautious as many factors remain unpredictable. We continue to experience logistic, supply chain, and manufacturing challenges that we expect will continue into 2022. As economies around the world continue to recover, shortages in raw materials have become more widespread. During the latter half of fiscal year 2021, we have experienced shortages of certain materials and have used more of our inventory on hand than we have used historically. Shortages of materials, particularly micro-controller chips and associated electronic components, have caused and may continue to cause, delays in manufacturing products for our customers. In some cases, raw material shortages and delivery delays from our suppliers are communicated to us with very little advanced warning, which has caused operational and customer order fulfillment challenges. While we are dedicating significant resources to manage, mitigate, and resolve these issues, we currently expect supply chain challenges to continue to impact our ability to deliver products to our customers over the next several quarters. Increased freight charges and shipping delays have also become more common over the last few months and are expected to continue into the foreseeable future. Due to the rising cost environment, in addition to ongoing expense management, we have begun to raise prices on certain products. We anticipate to make pricing adjustments throughout fiscal year 2022. During the twelve months endedOctober 1, 2021 , our manufacturing facilities continued to operate with minimal disruption. In accordance with government guidelines, we have modified certain COVID-19 related protocols, including social distancing and mask requirements. In the event COVID-19 cases continue an upward trajectory, we may be required to re-implement certain COVID-19 related precautions. The full extent to which the COVID-19 pandemic and ensuing supply chain challenges have and will directly or indirectly impact us, including our business, financial condition, and results of operations, will depend on future developments that are highly uncertain and cannot be accurately predicted. We will continue to actively monitor the situation and may take further actions that alter our business operations or that we determine are in the best interests of our employees, customers, suppliers, and stockholders. For additional information on risks related to the pandemic and other supply chain risks that could impact our results, see Part I, Item 1A - Risk Factors.
Fiscal Year
Our fiscal year is the 52- or 53-week period ending on the Friday nearestSeptember 30 . Fiscal year 2021 was the 52-week period that endedOctober 1, 2021 , fiscal year 2020 was the 53-week period that endedOctober 2, 2020 , and fiscal year 2019 was the 52-week period that endedSeptember 27, 2019 . Set forth below is a discussion of our results of operations for fiscal years 2021, 2020 and 2019. 38 -------------------------------------------------------------------------------- Table of Contents Results of Operations Our annual report on Form 10-K for the fiscal year endedOctober 2, 2020 , filedNovember 30, 2020 , includes a discussion and analysis of our year-over-year changes, financial condition, and results of operations for the fiscal years endedOctober 2, 2020 andSeptember 27, 2019 in Item 7 of Part II therein. Comparison of Results of Operations for Fiscal Year 2021 and 2020 Revenues, net (In millions) 2021 % Change 2020 % Change 2019 Medical$ 643.8 10%$ 584.5 (2)%$ 596.8 Industrial 174.3 13% 153.8 (16)% 183.8 Total revenues, net$ 818.1 11%$ 738.3 (5)%$ 780.6 Medical as a percentage of total revenues 79 % 79 % 76 % Industrial as a percentage of total revenues 21 % 21 % 24 %
Medical revenues increased
Industrial revenues increased$20.5 million due to increased sales of X-ray tubes for airport security and digital detectors for inspection applications. Revenues by Region (In millions) 2021 % Change 2020 % Change 2019 Americas$ 268.5 5%$ 255.0 (10)%$ 282.6 EMEA 276.3 19% 231.5 (14)% 269.0 APAC 273.3 9% 251.8 10% 229.0 Total revenues, net$ 818.1 11%$ 738.3 (5)%$ 780.6 Americas as a percentage of total revenues 33 % 35 % 36 % EMEA as a percentage of total revenues 34 % 31 % 34 % APAC as a percentage of total revenues 33 % 34 % 29 % TheAmericas revenues increased$13.5 million primarily due to increased sales of X-ray tubes, digital detectors and computer-aided detection software. EMEA revenues increased$44.8 million primarily due to increased sales of digital detectors, high voltage cables, and X-ray tubes. APAC revenues increased$21.5 million primarily due to increased sales of OEM X-ray tubes inChina . Gross Profit (In millions) 2021 % Change 2020 % Change 2019 Medical$ 203.2 49%$ 136.4 (28)%$ 188.9 Industrial 68.3 27% 53.8 (21)% 67.8 Total gross profit$ 271.5 43%$ 190.2 (26)%$ 256.7 Medical gross margin 32 % 23 % 32 % Industrial gross margin 39 % 35 % 37 % Total gross margin 33 % 26 % 33 % Gross margin increased for fiscal year 2021 compared to 2020. The gross profit for fiscal year 2020 included$22.2 million of restructuring and product discontinuation charges and purchase price accounting adjustments. The medical segment gross margin in 2021 increased primarily due to increased volumes of X-ray tubes and medical detectors, cost reduction actions undertaken in fiscal year 2020, which have resulted in cost savings in fiscal year 2021, and favorable product mix. The industrial segment gross margin in 39 -------------------------------------------------------------------------------- Table of Contents 2021 increased primarily due to higher volumes of X-ray tubes for security applications and non-destructive testing, favorable product mix, and cost reduction actions undertaken in fiscal year 2020, which have resulted in cost savings in fiscal year 2021. Operating Expenses (In millions) 2021 % Change 2020 % Change 2019 Research and development$ 71.9 (9)%$ 78.9 1%$ 78.1 As a percentage of total revenues 8.8 % 10.7 % 10.0 %
Selling, general and administrative
11%$ 128.1 As a percentage of total revenues 15.3 % 19.3 % 16.4 %
Impairment of intangible assets $ - (100)%
(42)%$ 4.8 As a percentage of total revenues - % 0.4 % 0.6 % Operating expenses$ 197.4 (12)%$ 223.9 6%$ 211.0 As a percentage of total revenues 24.1 % 30.3 % 27.0 %
Research and Development
Research and development costs for fiscal year 2021 decreased to 8.8% of revenues due to lower engineering related material purchases and cost reduction actions undertaken in fiscal year 2020, which have resulted in cost savings in fiscal year 2021, as well as higher revenues in fiscal year 2021. We are committed to investing in research and development efforts to support long-term growth objectives by bringing new and innovative products to market for our customers. Selling, General and Administrative Selling, general and administrative expenses as a percentage of total revenues decreased to 15.3% for fiscal year 2021 from 19.3% for fiscal year 2020 due to lower audit and consulting fees associated with the remediation of internal control deficiencies, cost reduction actions undertaken in fiscal year 2020, which have resulted in cost savings in fiscal year 2021. Impairment of intangible assets Impairment of intangible assets decreased for fiscal year 2021 to$0.0 million as compared to$2.8 million for fiscal year 2020. See Note 12.Goodwill and Intangible Assets, included in the accompanying notes to our consolidated financial statements for further information. Interest and Other Expense, Net The following table summarizes our interest and other expense, net: (In millions) 2021 % Change 2020 % Change 2019 Interest income$ 0.1 -%$ 0.1 -%$ 0.1 Interest expense (42.1) 34% (31.4) 49% (21.1) Other expense, net (3.5) (54)% (7.6) 138% (3.2)
Interest and other expenses, net
61%
Interest and other expense, net increased in fiscal year 2021 compared to fiscal year 2020. Interest expense increased primarily due to the interest related to our Convertible Notes issued duringJune 2020 , and the issuance of our Senior Secured Notes inSeptember 2020 which had higher effective interest rates, as well as the partial extinguishment of the Senior Secured Notes. Other expense, net decreased in fiscal year 2021 compared to fiscal year 2020. Other expense, net during fiscal year 2020 consisted primarily of the impairment of certain investments in privately-held companies and a decrease in the fair value of the deferred consideration related to the Direct Conversion acquisition, which did not recur during fiscal year 2021. Taxes on Income Fiscal Years 2021 2020 Effective tax rate 37.4 % 20.9 % 40
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We had an income tax expense of$10.7 million and an income tax benefit of$15.2 million , for effective rates of 37.4% and 20.9%, for fiscal years 2021 and 2020, respectively. During fiscal year 2021, our effective tax rate varied from theU.S. federal statutory rate of 21% primarily due to the unfavorable impact ofU.S. deferred tax attributes and losses in certain foreign jurisdictions for which no benefit is recognized and a reduction in benefit forU.S. net operating losses carried back to prior years. These unfavorable items are partially offset by the favorable impact of R&D tax credits andU.S. tax reform international provisions. During fiscal year 2020, our effective tax rate varied from theU.S. federal statutory rate of 21% primarily because of the favorable impact ofU.S. net operating losses to be carried back to tax years with greaterU.S. federal statutory rates. These favorable tax items are mostly offset by the unfavorable impact of additional losses in certain foreign jurisdictions, limitations on interest expense, and R&D credits for which no benefit is recognized. We estimated the fiscal year 2021 GILTI (global intangible low-taxed income), BEAT (base-erosion anti-abuse tax), FDII (foreign-derived intangible income), limitations on interest expense deductions, and other components ofU.S. Tax Reform, and have included these amounts in the calculation of the fiscal year 2021 tax provision. We made an accounting policy election, as allowed by theSEC and FASB, to recognize the impact of GILTI as a period cost if and when incurred.
Liquidity and Capital Resources
We assess our liquidity in terms of our ability to generate cash to fund our operations, including working capital and investing activities. We continue to generate cash from operating activities and believe that our operating cash flow, cash on our balance sheet and availability under our ABL Facility will be sufficient to allow us to continue to invest in our existing businesses, to manage our capital structure on a short and long-term basis, and to meet our anticipated operating cash needs. The maximum availability under our ABL Facility was$100.0 million as ofOctober 1, 2021 ; however, the borrowing base under the ABL Facility fluctuates from month-to-month depending on the amount of eligible accounts receivable and inventory. See Item 1A. "Risk Factors" for a further discussion. AtOctober 1, 2021 we had$431.7 million in long-term debt, net of discounts and deferred issuance costs of$46.1 million . OnJuly 15, 2021 , the Company redeemed$30 million of principal of our$300 million , 7.875% Senior Secured Notes due 2027 (the "Senior Secured Notes"), in accordance with the terms and conditions of the governing indenture by paying cash of$31.5 million , inclusive of the redemption premium and accrued interest, and recognized a$1.4 million loss related to the redemption premium and the write-off of previously recorded debt issuance costs. See Note 10. Borrowings, in the accompanying notes to our consolidated financial statements for more information regarding our indebtedness. Our consolidated cash and cash equivalents increased from$100.6 million as ofOctober 2, 2020 , to$144.6 as ofOctober 1, 2021 . This increase was primarily due to cash inflows from operating activities of$92.6 million , offset by capital expenditures of$15.1 million and debt repayments of$33.1 million . Cash and Cash Equivalents The following table summarizes our cash and cash equivalents: (In millions) October 1, 2021 October 2, 2020 $ Change % Change Cash and cash equivalents $ 144.6 $ 100.6$ 44.0 43.7 % 41
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The following table summarizes the changes in our debt outstanding: (In millions, except for percentages)
October 1, 2021 October 2, 2020 $ Change % Change
Current maturities of long-term
debt
Current portion of other debt $ 2.8 $ 2.5 $ 0.3 $ 0.1
Total current maturities of
long-term debt: $ 2.8 $ 2.5 $ 0.3 12.0 %
Non-current maturities of
long-term debt:
Convertible Senior Unsecured Notes $ 200.0 $ 200.0 $ - - %
Senior Secured Notes 270.0 300.0 (30.0) (10.0) %
Other debt 7.8 8.8 (1.0) (11.4) %
Total non-current maturities of
long-term debt: $ 477.8 $ 508.8 $ (31.0) (6.1) %
Unamortized issuance costs and
debt discounts
Unamortized discount - Convertible
Notes $ (37.6) $ (45.4) $ 7.8 (17.2) %
Unamortized issuance costs -
Convertible Notes (4.1) (5.0) 0.9 (18.0) %
Debt issuance costs - Senior
Secured Notes (4.4) (5.6) 1.2 (21.4) %
Total $ (46.1) $ (56.0) $ 9.9 (17.7) %
Total debt outstanding, net $ 434.5 $ 455.3 $ (20.8) (4.6) %
Cash Flows
Fiscal Years
(In millions) 2021 2020 2019
Net cash flow provided by (used in):
Operating activities $ 92.6 $ 13.2 $ 71.9
Investing activities (16.2) (26.9) (93.2)
Financing activities (32.3) 83.6 (0.1)
Effects of exchange rate changes on cash and cash
equivalents (0.1) 0.9 (0.7)
Net increase (decrease) in cash and cash equivalents
70.8
Net Cash Provided by Operating Activities. Cash from operating activities consists primarily of net income adjusted for certain non-cash items, including share-based compensation, depreciation, amortization and impairment of intangible assets, inventory write-downs, deferred income taxes, amortization of deferred loan costs, income and loss from equity investments and the effect of changes in operating assets and liabilities. For fiscal year 2021, compared to fiscal year 2020, net cash provided by operating activities were as follows: •Net income of$17.9 million compared to net loss of$57.4 million , •Non-cash adjustments to net income were$66.5 million compared to$84.5 million , •Operating assets and liabilities activity: •Accounts receivable increased by$32.9 million compared to a decrease of$17.7 million , •Inventories decreased by$42.8 million compared to an increase of$42.7 million , •Prepaid expenses and other assets increased by$0.9 million compared to$9.3 million , •Accounts payable increased by$13.6 million compared to a decrease of$14.3 million , •Accrued liabilities and other long-term operating liabilities decreased by$12.2 million compared to a decrease of$8.1 million , and •Deferred revenues decreased by$0.6 million compared to an increase of$2.0 million . Net cash used in investing activities. Cash used in investing activities was$16.2 million and$26.9 million for the fiscal years 2021 and 2020, respectively. The decrease in cash used in investing activities was primarily due to higher capital spending during the twelve months endedOctober 2, 2020 , related primarily to the building of our facility inthe Netherlands . 42
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Net Cash Provided by (Used in) Financing Activities. We used$32.3 million of cash in financing activities for the twelve months endedOctober 1, 2021 . Net cash used in financing activity for the twelve months endedOctober 1, 2021 , was primarily due to our early redemption of$30 million of our Senior Secured Notes. Net cash provided by financing activity for the twelve months endedOctober 2, 2020 , was primarily due to our issuance of$200.0 million in aggregate principal amount of 4.00% unsecured convertible senior notes due 2025 ("Convertible Notes"). The net proceeds from the issuance of the Convertible Notes, after deducting transaction fees, were approximately$193.1 million . In connection with the offering of the Convertible Notes, we separately entered into privately negotiated convertible note hedge transactions (collectively, the "Hedge Transactions"). The Hedge Transactions cover, subject to customary anti-dilution adjustments, the number of shares of our common stock that initially underlay the Convertible Notes. We also entered into warrant transactions (collectively, the "Warrant Transactions" and, together with the Hedge Transactions, the "Call Spread Transactions"), whereby we sold warrants at a higher strike price relating to the same number of shares of our common stock that initially underlay the Convertible Notes, subject to customary anti-dilution adjustments. We used$11.2 million of the net proceeds from the issuance of the Convertible Notes to pay the cost of the Call Spread Transactions. Additionally, during the twelve months endedOctober 2, 2020 , we had borrowings under our credit agreement of$91.7 million and repayments of borrowings of$218.0 million . Additionally, during fiscal year 2020 we issued$300.0 million aggregate principal amount of Senior Secured Notes. The net proceeds from the Senior Secured Notes after initial purchasers' discount, commissions and estimated fees and expenses of$5.6 million , were approximately$294.4 million . We used$267.5 million of the proceeds from the offering to terminate and repay our previously existing credit agreement. Days Sales Outstanding Trade accounts receivable days sales outstanding ("DSO") was 62 days and 66 days atOctober 1, 2021 andOctober 2, 2020 , respectively. Our accounts receivable and DSO are impacted by a number of factors, primarily including the timing of product shipments, collections performance, payment terms, the mix of revenues from different regions and the effects of economic instability. Contractual Obligations
The following table summarizes, as of
Payments Due by Period
Fiscal Year Fiscal Years Fiscal Years
(In millions) Total 2022 2023-2024 2025-2026 Beyond
Lease obligations $ 29.9 $ 7.6
2.8 4.3 203.1 270.4
dpiX fixed cost commitment 2.9 2.9 - - -
Dividends to MeVis noncontrolling
interest 3.8 0.5 1.1 1.1 1.1
Supplier equipment acquisition 9.8 9.8 - - -
Total $ 527.0 $ 23.6 $ 14.7 $ 210.5 $ 278.2 We lease office space under non-cancelable operating leases. For further information on our operating leases, see Note 3. Leases, included in the accompanying notes to our consolidated financial statements.
For further discussion regarding our borrowings, see Note 10. Borrowings, included in the accompanying notes to our consolidated financial statements.
InOctober 2013 , we entered into an amended agreement with dpiX and other parties that, among other things, provides us with the right to 50% of dpiX's total manufacturing capacity produced afterJanuary 1, 2014 . The amended agreement requires us to pay for 50% of the fixed costs (as defined in the amended agreement), as determined at the beginning of each calendar year. For the remainder of calendar year 2021, we estimate that we have fixed cost commitments of$2.9 million related to this amended agreement. The fixed cost commitment for future periods will be determined and approved by the dpiX board of directors at the beginning of each calendar year. The amended agreement will continue unless the ownership structure of dpiX changes (as defined in the amended agreement). InOctober 2015 , pursuant to a Domination and Profit and Loss Transfer Agreement (the "MeVis Agreement"), we committed to grant the noncontrolling shareholders of MeVis: (1) an annual recurring net compensation of €0.95 per MeVis share; and, (2) a put right for their MeVis shares at €19.77 per MeVis share. The annual net payment will continue for the life of the MeVis 43 -------------------------------------------------------------------------------- Table of Contents Agreement, which we anticipate will continue for as long as we remain as the controlling shareholder of MeVis. As ofOctober 1, 2021 , noncontrolling shareholders together held approximately 0.5 million shares of MeVis, representing 26.3% of the outstanding shares. Varex entered into a purchase agreement with a supplier to acquire certain equipment and intellectual property from the supplier that is utilized to manufacture X-ray cables utilized in Varex's products. For more information about our supplier equipment acquisition, see Note 13. Commitments and Contingencies, included in the accompanying notes to our consolidated financial statements.
Contingencies
From time to time, the Company is a party to or otherwise involved in legal proceedings, claims and government inspections or investigations, customs and duty audits, other contingency matters, both inside and outsidethe United States , arising in the ordinary course of its business or otherwise. The Company accrues amounts for probable losses, to the extent they can be reasonably estimated, that it believes are adequate to address any liabilities related to legal proceedings and other loss contingencies that the Company believes will result in a probable loss (including, among other things, probable settlement value). A loss or a range of loss is disclosed when it is reasonably possible that a material loss will be incurred and can be estimated or when it is reasonably possible that the amount of a loss, when material, will exceed the recorded provision. The Company did not have any material contingent liabilities as ofOctober 1, 2021 andOctober 2, 2020 . Legal expenses are expensed as incurred. See Part 1, Item 3 of this Annual Report for additional information regarding legal proceedings and Note 13. Commitments and Contingencies, in the notes to our consolidated financial statements for further information regarding certain of our contractual obligations and contingencies, which discussion is incorporated herein by reference. Off-Balance Sheet Arrangements In conjunction with the sale of our products in the ordinary course of business, and consistent with industry practice, we provide standard indemnification of business partners and customers for losses suffered or incurred for property damages, death and injury and for patent, copyright or any other intellectual property infringement claims by any third parties with respect to our products. The terms of these indemnification arrangements are generally perpetual. Except for losses related to property damages, the maximum potential amount of future payments we could be required to make under these arrangements is unlimited. As ofOctober 1, 2021 , we have not incurred any material costs to defend lawsuits or settle claims related to these indemnification arrangements. As a result, we believe the estimated fair value of these arrangements is minimal. We also have indemnification obligations to our directors and officers and certain of our employees that serve as officers or directors of our foreign subsidiaries that may require us to indemnify our directors and officers and those certain employees against liabilities that may arise by reason of their status or service as directors or officers, and to advance their expenses incurred as a result of any legal proceeding against them as to which they could be indemnified. Critical Accounting Policies and Estimates The preparation of our consolidated financial statements and related disclosures in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates and assumptions are based on historical experience and on various other factors that we believe are reasonable under the circumstances. Our critical accounting policies that are affected by accounting estimates require us to use judgments, often as a result of the need to make estimates and assumptions regarding matters that are inherently uncertain, and actual results could differ materially from these estimates. We periodically review our accounting policies, estimates and assumptions and make adjustments when facts and circumstances dictate. Such accounting policies require us to use judgments, often as a result of the need to make estimates and assumptions regarding matters that are inherently uncertain, and actual results could differ materially from these estimates. Our critical accounting policies that are affected by accounting estimates include valuation of inventories, assessment of recoverability of goodwill and intangible assets, and income taxes. Such accounting policies require us to use judgments, often as a result of the need to make estimates and assumptions regarding matters that are inherently uncertain, and actual results could differ materially from these estimates. For a discussion of how these estimates and other factors may affect our business, see Item 1A. "Risk Factors." Inventories Inventories are valued at the lower of cost or net realizable value. Costs include materials, labor and manufacturing overhead and is computed using standard cost (which approximates actual cost) on a first-in-first-out basis. We evaluate the carrying value of 44 -------------------------------------------------------------------------------- Table of Contents our inventories taking into consideration such factors as historical and anticipated future sales compared to quantities on hand and the prices we expect to obtain for products in our various markets. We adjust excess and obsolete inventories to net realizable value and write-downs of excess and obsolete inventories are recorded as a component of cost of revenues.Goodwill and Intangible AssetsGoodwill is initially recorded when the purchase price paid for a business acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. Our future operating performance will be impacted by the future amortization of these acquired intangible assets and potential impairment charges related to these intangibles or to goodwill if indicators of impairment exist. The allocation of the purchase price from business acquisitions to goodwill and intangible assets could have a material impact on our future operating results. In addition, the allocation of the purchase price of the acquired businesses to goodwill and intangible assets requires us to make significant estimates and assumptions, including estimates of future cash flows expected to be generated by the acquired assets and the appropriate discount rate for those cash flows. Should conditions differ from management's estimates at the time of the acquisition, material write-downs of intangible assets and/or goodwill may be required, which would adversely affect our operating results. We evaluate goodwill for impairment at least annually or whenever an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The evaluation includes consideration of qualitative factors including industry and market considerations, overall financial performance, and other relevant events and factors affecting the reporting unit. If we determine that a quantitative analysis is necessary, we perform a quantitative analysis which consists of a comparison of the fair value of a reporting unit against its carrying amount, including the goodwill allocated to each reporting unit. We determine the fair value of our reporting units based on a combination of income and market approaches. The income approach is based on the present value of estimated future cash flows of the reporting units and the market approach is based on a market multiple calculated for each reporting unit based on market data of other companies engaged in similar business. If the carrying amount of the reporting unit is in excess of its fair value, the difference between the fair value and carrying amount is recorded as an impairment loss. The impairment test for intangible assets with indefinite useful lives, if any, consists of a comparison of fair value to carrying value, with any excess of carrying value over fair value being recorded as an impairment loss. In fiscal years 2021, 2020 and 2019, we performed the annual goodwill impairment test for our two reporting units and found no impairment. We performed the annual goodwill analysis as of the first day of the fourth quarter of each fiscal year (using balances as of the end of the third quarter of that fiscal year). For both reporting units, based upon the annual goodwill analysis that we performed as of the first day of the fourth quarter of the respective fiscal years, either a quantitative analysis of the impairment test was not completed based on evaluation of qualitative factors or, if quantitative analysis was completed, the fair value was substantially in excess of carrying value. However, significant changes in our projections of our operating results or other factors could cause us to make interim assessments of impairments in any quarter that could result in some or all of the goodwill being impaired. Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions, estimates, and market factors. Estimating the fair value of individual reporting units requires us to make assumptions and estimates regarding our future plans, as well as industry, economic, and regulatory conditions. These assumptions and estimates include estimated future annual net cash flows, income tax rates, discount rates, revenue growth rates, forecasted gross margins, market multiples, terminal value and other market factors. This fair value measurement was based on significant inputs not observable in the market and thus represents a Level 3 fair value measurement. If current expectations of future revenue growth rates and forecasted gross margins, both in size and timing, are not met, if market factors outside of our control, such as discount rates, change, if market multiples decline, or if management's expectations or plans otherwise change, including as a result of the development of our global five-year operating plan, then one or more of our reporting units might become impaired in the future. The Company will continue to monitor the financial performance of and assumptions for its reporting units. A future impairment charge for goodwill could have a material effect on the Company's consolidated financial position and results of operations.
We will continue to make assessments of impairment on an annual basis or more frequently if indicators of potential impairment arise. Taxes on Income
Current income tax expense or benefit is the amount of income taxes expected to be payable or receivable for the current year. Deferred income tax liabilities or assets are established for the expected future tax consequences resulting from the differences in financial reporting and tax bases of assets and liabilities. Future changes in tax regulation can have a material impact, including tax rate changes or the realization of deferred tax assets. A valuation allowance is provided if it is more likely than not that some or all of the deferred tax assets will not be realized.U.S. Tax Reform introduced a limitation of business interest deduction under IRC Section 163(j), which may be difficult to utilize without significant taxable income. Also, net operating loss carryforwards in jurisdictions with 45 -------------------------------------------------------------------------------- Table of Contents current losses provide uncertainty for realization. In addition, we provide reserves for uncertain tax positions when such tax positions do not meet the recognition thresholds or measurement standards prescribed by the authoritative guidance for accounting for income taxes. A portion of theU.S. general business tax credits for research outside of the financial statement line for research and development (R&D) have a small degree of uncertainty. A reasonable reserve is maintained on the uncertain portion until either the Internal Revenue Service chooses to audit, or the statute of limitation expires. A reserve for R&D is typical for companies who calculate and utilize this general business credit. Amounts for uncertain tax positions are adjusted in periods when new information becomes available or when positions are effectively settled. Interest and penalties related to uncertain tax positions are recognized as a component of income tax expense. OnMarch 27, 2020 , the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was enacted in response to the COVID-19 pandemic. The CARES Act, among other things, permits net operating loss ("NOL") carryovers and carrybacks to offset 100% of taxable income for taxable years beginning before 2021. In addition, the CARES Act allows NOLs incurred in 2018, 2019, and 2020 to be carried back to each of the five preceding taxable years to generate a refund of previously paid income taxes. OnJuly 2, 2020 , theUS Treasury Department issued a regulation providing an election to waive NOL carryback to a former consolidated group. During fiscal year 2021, we filed NOL carryback claims forU.S. losses incurred in fiscal year 2020 and anticipates cash tax refunds on those claims. Recent Accounting Standards or Updates Not Yet Effective See Note 1. Summary of Significant Accounting Policies, of the notes to the consolidated financial statements for a description of recent accounting standards, including the expected dates of adoption and the estimated effects on our consolidated financial statements.
Backlog
Backlog is the accumulation of all orders for which revenues have not been recognized and are still considered valid. Backlog also includes a small portion of billed service contracts that are included in deferred revenue. Our estimated total backlog atOctober 1, 2021 was approximately$327 million . Orders may be revised or canceled, either according to their terms or as customers' needs change. Consequently, it is difficult to predict with certainty the amount of backlog that will result in revenues. We perform a quarterly review to verify that outstanding orders in the backlog remain valid. Aged orders that are not expected to be converted to revenues are deemed dormant and are reflected as a reduction in the backlog amounts in the period identified. In addition to orders for which revenues have not been recognized and are still considered valid, we have pricing agreements with many of our established customers that span multi-year periods. These pricing agreements include volume ranges under which orders are placed. Item 7A. Quantitative and Qualitative Disclosures about Market Risks
We are exposed to four primary types of market risks: foreign currency exchange rate risk, credit and counterparty risk, interest rate risk and commodity price risk. Foreign Currency Exchange Rate Risk
A significant portion of our customers are outsidethe United States , while our financial statements are denominated, and our products are generally priced inU.S. Dollars. A strongU.S. Dollar may result in pricing pressure for our customers that are located outsidethe United States and that conduct their businesses in currencies other than theU.S. Dollar. Such pricing pressure has caused, and could continue to cause, some of our customers to ask for discounted prices, delay purchasing decisions, consider moving to in-sourcing supply of components or migrating to lower cost alternatives. In addition, because our business is global and some payments may be made in local currency, fluctuations in foreign currency exchange rates can impact our revenues and expenses and/or the profitability inU.S. Dollars of products and services that we provide in foreign markets. We may enter into foreign currency forward and option contracts with financial institutions to protect against foreign exchange risks associated with certain existing assets and liabilities, and net investments in foreign subsidiaries. We generally hedge portions of forecasted foreign currency exposure, typically for one to three months. In addition, we hold a cross-currency swap between the Euro andU.S. Dollar as a Net Investment Hedge of our acquisition of Direct Conversion. Depending on the spot rate between the Euro andU.S. Dollar at the time of settlement and whether we have sufficient Euros available, we may have to borrow incrementally inU.S. Dollars to settle this obligation. Additionally, we may choose not to hedge certain foreign exchange exposures 46 --------------------------------------------------------------------------------
for a variety of reasons including, but not limited to, accounting considerations, the prohibitive economic cost of hedging particular exposures, or due to natural offsets among the different exposures. Credit and Counterparty Risk
We use a centralized approach to manage substantially all of our cash and to finance our operations. Our cash and cash equivalents may be exposed to a concentration of credit risk and we may also be exposed to credit risk and interest rate risk to the extent that we enter into credit facilities.
We perform ongoing credit evaluations of our customers and we maintain what we believe to be strong credit controls in evaluating and granting customer credit, including performing ongoing evaluations of our customers' financial condition and creditworthiness and often using letters of credit and requiring certain Industrial customers to provide a down payment. Interest Rate Risk Borrowings under our ABL Facility bear interest at floating interest rates. AtOctober 1, 2021 , we had no borrowings subject to floating interest rates. See Note 10. Borrowings, of the notes to our consolidated financial statements for further information. Commodity Price Risk We are exposed to market risks related to volatility in the prices of raw materials used in our products. The prices of these raw materials fluctuate in response to changes in supply and demand fundamentals and our product margins and level of profitability tend to fluctuate with changes in these raw materials prices. We try to protect against such volatility through various business strategies. During the fiscal year endedOctober 1, 2021 , we did not have any commodity derivative instruments in place to manage our exposure to price changes. Item 8. Financial Statements and Supplementary Data. The Consolidated Financial Statements and Schedules listed in the Index to Consolidated Financial Statements, Schedules and Exhibits on page F-1 are filed as part of this Annual Report and incorporated in this Item 8 by reference. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None. Item 9A. Controls and Procedures. Evaluation of Disclosure Controls and Procedures Our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act") are designed to provide reasonable assurance that information required to be disclosed in our periodic reports that we file or submit under the Exchange Act are recorded, processed, summarized, and reported within the time periods specified in the rules and forms of theSecurities and Exchange Commission and that such information is accumulated and communicated to our management, including our principal executive and financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed, and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on this evaluation, the Chief Executive Officer (CEO) and Chief Financial Officer (CFO) have concluded that our disclosure controls and procedures were effective as ofOctober 1, 2021 .
Management's Annual Report on Internal Control Over Financial Reporting
Management, under the supervision of our CEO and CFO, is responsible for establishing and maintaining adequate internal control over our financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our management evaluated the design and operating effectiveness of our internal control over financial reporting based on the criteria established in the Internal Control-Integrated Framework (2013) issued by theCommittee of Sponsoring Organizations of theTreadway Commission (the 47 --------------------------------------------------------------------------------
"COSO framework" (2013)). All internal control systems, no matter how well designed, have inherent limitations. Accordingly, even effective internal controls and procedures can provide only reasonable assurance with respect to financial statement preparation and presentation.
Under the supervision and with the participation of our management, we
conducted an evaluation of the effectiveness of our internal control over
financial reporting as of
The effectiveness of our internal control over financial reporting as of
Previously Identified Material Weaknesses in Internal Control Over Financial Reporting
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.
We previously identified and disclosed in our Annual Report on Form 10-K for the year endedOctober 2, 2020 material weaknesses in our internal control over financial reporting relating to the following: •Control Environment: We did not maintain an effective control environment as we had an insufficient complement of resources with the requisite knowledge and experience to create the proper environment for effective internal control over financial reporting such that corrective activities to our internal control over financial reporting are appropriately applied, prioritized, and implemented in a timely manner. •Risk Assessment: We did not design and maintain an effective risk assessment process to identify and assess the risks in our business processes. Specifically, we did not adequately identify new and evolving risks of material misstatement and design and implement controls to address those risks as a result of changes to our business operating environment. •Inventory and cost of revenues: We did not design and maintain effective controls related to accounting for inventory and cost of revenues, including maintaining effective business process controls to prevent or detect misstatements in the existence, accuracy, and presentation and disclosure of inventory. Specifically, we did not maintain effective controls related to the verification of inventory at third party vendor locations and the presentation and disclosure of inventory classification. •Financial Reporting: We did not design and maintain effective controls over our financial reporting close process to prevent or detect material misstatements in our financial statements. Specifically, we did not design and maintain effective controls related to the completeness, accuracy and elimination of intercompany balances and ensuring appropriate segregation of duties as it relates to the preparation and review of journal entries.
Remediation Efforts of Previously Disclosed Material Weaknesses
Subsequent to the evaluation made in connection with filing our Annual Report on Form 10-K for the year endedOctober 2, 2020 , management, with the oversight of the Audit Committee of the Board of Directors, continued the process of remediating the material weaknesses.
During the year ended
•We invested significantly in the quality of our accounting talent including management, technical, process improvement and financial system roles. Additionally, we implemented programs to: improve our talent acquisition and retention platforms; enhance technical, transactional and control knowledge of our accounting teams; and created a culture of accountability and control. These programs have significantly improved the stability of our global accounting organization.
•We completed a gap analysis of our key controls. In completing this analysis, we identified areas where new controls were necessary and enhancements to existing controls, policies and procedures needed to be made.
48
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•Implementing or enhancing controls in the inventory business process over (i)
verification of inventory at third party vendor locations and (ii) presentation
and disclosure of inventory classification.
•Implementing or enhancing controls in the financial reporting close process
over (i) journal entry posting rights and responsibilities, (ii) appropriate
level of segregation of duties and (ii) completeness, accuracy and elimination
of intercompany balances.
As a result of these remediation activities and based on the result of the
operating effectiveness testing we performed for the new and modified controls,
we concluded the previously reported material weaknesses have been fully
remediated as of October 1, 2021 .
Changes in Internal Control Over Financial Reporting
Other than the remediation efforts of previously disclosed material weaknesses described above, there were no changes to our internal control over financial reporting during the quarter endedOctober 1, 2021 , that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 49
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and the Board of Directors of
Opinion on Internal Control over Financial Reporting
We have audited the internal control over financial reporting ofVarex Imaging Corporation and subsidiaries (the "Company") as ofOctober 1, 2021 , based on criteria established in Internal Control - Integrated Framework (2013) issued by theCommittee of Sponsoring Organizations of theTreadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as ofOctober 1, 2021 , based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO. We have also audited, in accordance with the standards of thePublic Company Accounting Oversight Board (United States ) (PCAOB), the consolidated financial statements as of and for the year endedOctober 1, 2021 of the Company and our report datedNovember 19, 2021 , expressed an unqualified opinion on those financial statements.
Basis for Opinion
The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with theU.S. federal securities laws and the applicable rules and regulations of theSecurities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/Deloitte & Touche LLP Salt Lake City, Utah November 19, 2021 50
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