VAREX IMAGING CORPORATION The following discussion and analysis of the financial condition and results should be read together with the unaudited condensed consolidated financial statements and notes thereto that are contained in this Quarterly Report on Form 10-Q (this "Quarterly Report") as well as our Annual Report on Form 10-K for the fiscal year endedSeptember 30, 2022 and our other filings, including the Current Reports on Form 8-K, that have been filed with theSecurities and Exchange Commission ("SEC ") through the date of this report. In this Quarterly Report, unless otherwise specified or the context otherwise requires, the "Company," "Varex," "we," "us," and "our" refer toVarex Imaging Corporation . Forward-Looking Statements This Quarterly Report contains "forward-looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995, which provides a "safe harbor" for statements about future events, products and future financial performance that are based on the beliefs of, estimates made by, and information currently available to the management of Varex. Actual results and the outcome or timing of certain events described in these forward-looking statements are subject to risk and uncertainties and may differ significantly from those projected in these forward-looking statements. Important factors that could cause our actual results and financial condition to differ significantly from those projections or expectations include, among other things, the risks outlined in the Summary of Principal Risk Factors and further described in the Risk Factors listed in Part II, Item 1A -"Risk Factors" of this Quarterly Report. Statements concerning: supply chain and logistics challenges; cost increases; the continuing impact of the ongoing COVID-19 pandemic on the global economy or the Company; the effects of inflation; industry or market segment outlook; market acceptance of or transition to new products or technology such as advanced X-ray tube and digital flat panel detector products; growth drivers; future orders, revenues, backlog, earnings or other financial results; and any statements using the terms "believe," "expect," "anticipate," "can," "should," "would," "could," "estimate," "may," "intended," "potential," and "possible" or similar statements are forward-looking statements that involve risks and uncertainties that could cause our actual results and the outcome and timing of certain events to differ materially from those projected or management's current expectations. Any forward-looking statement made in this Quarterly Report (including in any exhibits or documents incorporated by reference) is based only on information currently available to Varex and its management and speaks only as of the date on which it is made. We have not assumed any obligation to, and you should not expect us to, update or revise those statements because of new information, future events or otherwise.
Overview
Varex Imaging Corporation is a leading innovator, designer and manufacturer of X-ray imaging components including tubes, digital detectors, linear accelerators, image software processing solutions and stand-alone X-ray based systems in select application areas. Our components are used in medical diagnostic imaging, security inspection systems, and industrial quality inspection systems, as well as for analysis and measurement applications in industrial manufacturing applications. Global original equipment manufacturers ("OEMs") incorporate our X-ray imaging components into their systems to detect, diagnose, protect, irradiate and inspect. Varex has approximately 2,300 full-time equivalent employees, located at engineering, manufacturing and service center sites inNorth America ,Europe , andAsia . Our products are sold in three geographic regions: theAmericas , EMEA, and APAC. TheAmericas includesNorth America (primarilythe United States ) andLatin America . EMEA includesEurope ,Russia , theMiddle East ,India andAfrica . APAC includesAsia (other thanIndia ) andAustralia . Revenues by region are based on the known final destination of products sold. 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 demand from our customers. We continually invest in research and development and employ approximately 300 individuals in product development related activities. Our focus on innovation and product performance along with strong and long-term customer relationships allows us to collaborate with our customers to bring industry-leading products to the X-ray imaging market. We continue to work to improve the life and quality of our imaging components and leverage our scale as one of the largest independent X-ray imaging component suppliers to provide cost-effective solutions for our customers. 27
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Impact of COVID-19, Inflation 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 fiscal year 2022, demand for many of our products recovered to pre-pandemic levels and our business grew. 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 and recent high rates of inflation have increased our costs and could negatively affect our future profit margins. The existence of inflation in the economy has resulted in, and may continue to result in, higher interest rates and capital costs, increased shipping costs, supply shortages, increased costs of labor and materials, weakening exchange rates and other similar effects. We continue to experience supply chain, manufacturing, and logistics challenges that we expect will continue into 2023. As economies around the world continue to recover, shortages in raw materials have become more widespread. During the latter half of fiscal year 2021 and throughout fiscal year 2022, we experienced shortages of certain materials and 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, manufacturing, and logistics 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 and are expected to continue into the foreseeable future. Due to the rising cost environment, in addition to ongoing expense management, we began to raise prices on certain products in fiscal year 2022 and anticipate making further pricing adjustments throughout fiscal year 2023. During the three months endedDecember 30, 2022 , our manufacturing facilities continued to operate with minimal disruption. Notwithstanding the foregoing, local government lockdowns, particularly inChina , have impacted, and could continue to impact, our manufacturing operations in affected countries. The full extent to which the COVID-19 pandemic and ensuing supply chain, manufacturing and logistics 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 we believe are in the best interest of the Company and our stockholders, which may include altering our business operations or other actions to benefit or protect our employees, customers or suppliers. For additional information on risks related to the pandemic and other supply chain risks that could impact our results, see Part II, Item 1A - "Risk Factors".
Operating Segments and Products
We have two reportable operating segments: Medical and Industrial. The segments align our products and service offerings with customer use in medical and industrial markets.
Medical
In our Medical segment, we design, manufacture, sell and service X-ray imaging
components, including X-ray tubes, digital detectors and accessories, ionization
chambers and buckys, high voltage connectors, image-processing software and
workstations, 3D reconstruction software, computer-aided diagnostic software,
collimators, automatic exposure control devices, generators, and heat
exchangers. These components are used in a range of medical imaging applications
including CT, mammography, oncology, cardiac, surgery, dental, and other
diagnostic radiography uses.
Our X-ray imaging components are primarily sold to OEM customers. These OEM
customers then design-in our products into their X-ray imaging systems for a
variety of medical modalities. A substantial majority of medical X-ray imaging
OEMs globally are our customers, and many of these have been our customers for
over 25 years. We believe one of the reasons for customer loyalty is that our
hardware and software products are tightly integrated with our customers'
systems. We work very closely with our customers to create custom built
components for their systems based on technology platforms that we have
developed. Because our products are often customized for our customers' specific
equipment, it can be costly and complex for our customers to switch to another
provider. Once our components are designed into our customers' equipment, our
customers will typically continue to buy from us for any replacement components
and for service and support for that equipment. Some of our products are also
included in product registrations for our customers' equipment that require
regulatory approval to change. In addition to sales to OEM customers, we sell
our products to independent service companies and distributors as well as
directly to end-users for replacement purposes.
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We are one of the largest global manufacturers of X-ray imaging components and each year we produce over 28,000 X-ray tubes and 20,000 X-ray detectors. We estimate that our world-wide installed base of products includes more than 160,000 X-ray tubes, 170,000 X-ray detectors, 600,000 connect and control components and 16,000 software instances. Replacement and service of our existing installed base makes up a significant portion of our revenue. Many of our components need to be replaced regularly depending upon usage and other factors. For example,CT X -ray tubes generally need to be replaced every 2 to 6 years, in comparison to a general radiography tube which can last up to 10 years, depending on utilization. InChina , the replacement cycle forCT X -ray tubes currently can be as frequent as every 10 to 20 months due to high utilization of imaging equipment. Other products such as X-ray detectors have a useful life of as much as 7 years or more, but can require more frequent service and repairs during their useful life. In addition, our detector customers often elect to upgrade products to newer technology before the end of a current product's useful life. X-ray imaging software is a relatively small part of our business and includes maintenance revenue for software licenses. The COVID-19 pandemic had a significant effect on hospitals, clinics and outpatient imaging centers as they encountered declines in elective procedures volume. As a result, they reduced the capital purchases of imaging equipment from OEMs, which led to lower demand for X-ray imaging components for us. Additionally, equipment installations were delayed, due to reduced access to healthcare institutions. Partially offsetting this was an increased demand for imaging equipment used to diagnose respiratory diseases, such as radiographic X-ray imaging systems and CT imaging systems. We have experienced growth in demand for our products as health systems globally have continued to address healthcare services gaps. However, we have not been able to convert all the demand into sales due to on-going supply chain related interruptions and uncertainties, particularly with the availability of micro-controller chips and other electronic components. As a result, uncertainty in overall sales volume is expected to continue at least through the fiscal year 2023. InChina , the government is broadening the availability of healthcare services. As a result, the number of diagnostic X-ray imaging systems, including CT, has grown significantly. We are developingCT X -ray tubes and related subsystems for Chinese OEMs as they introduce new systems inChina . Over the long-term, our objective is to become the partner of choice both for OEMs and in the replacement market as CT systems become more widely adopted throughout the Chinese market. In recent years our business inChina has been impacted by the trade war withthe United States in three principal ways: (1) importing raw materials fromChina tothe United States has become more expensive, (2) importing raw materials and sub-assemblies fromthe United States toChina has become more expensive, and (3) importing finishedU.S. manufactured products intoChina has become more difficult and expensive. While the governments of boththe United States andChina have granted tariff exclusions that temporarily eliminate the additional duties payable for specific commodities, providing partial relief, these exclusions are temporary and/or must be solicited and approved on a shipment-by-shipment basis. There is no guarantee that such exclusions will be granted or extended by either government. In order to mitigate the impact of tariffs on materials imported fromChina , we have implemented changes to secure more non-China sources of materials used to manufacture our X-ray imaging products. To help mitigate the impact of tariffs on materials imported toChina , and to be closer to our global customer base, we continue to expand manufacturing capabilities at our facilities inChina ,Germany ,the Netherlands andthe Philippines . We have also implemented local sourcing strategies to offer local content. This local-for-local strategy has been well received by both our local customers as well as global OEMs, and acts as a natural hedge against trade wars and other potential supply chain disruptions. Our mitigation efforts could prove less effective than anticipated if rising tensions betweenChina andTaiwan lead to worsening trade relations betweenChina andthe United States .
Industrial
In our Industrial segment, we design, develop, manufacture, sell and service
X-ray imaging products for use in a number of markets, including security
applications for cargo screening at ports and borders and baggage screening at
airports, and nondestructive testing, irradiation and inspection applications
used in a number of other vertical markets. Our industrial products include
Linatron® X-ray linear accelerators, X-ray tubes, digital detectors, high
voltage connectors and coolers. In addition, we license proprietary
image-processing and detection software designed to work with other Varex
products to provide packaged sub-assembly solutions to our industrial customers.
Our Industrial business benefits from the research and development investment
and manufacturing economies of scale on the Medical side of our business, as we
continue to find new applications for our technology. Along with more favorable
pricing dynamics, this allows us to generally achieve higher gross profit for
industrial products relative to our Medical business. In addition, our
Industrial business benefits from our long-term service agreements for our
Linatron® products.
The security market primarily consists of cargo security for the screening of
trucks, trains, and cargo containers at ports and borders as well as airport
security for carry-on baggage, checked baggage and palletized cargo. The end
customers for border protection systems are typically government agencies, many
of which are in oil-based economies and war zones where there can be significant
variation in buying patterns.
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Non-destructive testing and inspection verticals utilize X-ray imaging to scan items for inspection of manufacturing defects and product integrity in a wide range of industries including the aerospace, automotive, electronics, oil and gas, food packaging, metal castings and 3D printing industries. In addition, new applications for X-ray sources are being developed, such as sterilization of food and its packaging. We provide X-ray sources, digital detectors, high voltage connectors and image processing software to OEM customers, system integrators and manufacturers in a variety of these verticals. We believe that the non-destructive testing market represents a significant growth opportunity for our business, and we are actively pursuing new potential applications for our products. The economic downturn triggered by the COVID-19 pandemic reduced the demand for X-ray imaging equipment utilized in the non-destructive testing and security markets as manufacturers and end users focused on cash preservation and reduced spending for capital equipment. However, we have seen improved conditions in these markets, which continued during the three months endedDecember 30, 2022 .
Critical Accounting Policies and Estimates
The preparation of our condensed 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. Refer to our Annual Report on Form 10-K for the fiscal year endedSeptember 30, 2022 filed with theSEC onNovember 18, 2022 and Note 1, Summary of Significant Accounting Policies, of the Notes to the Condensed Consolidated Financial Statements of this report for further details. 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. Except for the change in certain policies upon adoption of the accounting standard described in Note 1, Summary of Significant Accounting Policies of the Notes to the Condensed Consolidated Financial Statements of this report, there have been no material changes to the Company's significant accounting policies, compared to the accounting policies described in Note 1, Summary of Significant Accounting Policies, in the Company's Annual Report on Form 10-K for fiscal year 2022. Fiscal Year
The fiscal years of the Company as reported are the 52 or 53-week period
ending on the Friday nearest
Discussion of Results of Operations for the Three Months Ended
Revenues, net
Three Months Ended
(In millions) December 30, 2022 December 31, 2021 $ Change % Change
Medical $ 160.1 $ 155.7 $ 4.4 2.8 %
Industrial 45.5 43.1 2.4 5.6 %
Total revenues $ 205.6 $ 198.8 $ 6.8 3.4 %
Medical as a percentage of total
revenues 77.9 % 78.3 %
Industrial as a percentage of
total revenues 22.1 % 21.7 %
Medical revenues increased
Industrial revenues increased$2.4 million , primarily due to increased sales of digital detectors for dynamic imaging applications, partially offset by lower sales of security inspection products. 30
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Gross Profit
Three Months Ended
(In millions) December 30, 2022 December 31, 2021 $ Change % Change
Medical $ 46.3 $ 46.0 $ 0.3 0.7 %
Industrial 17.0 18.8 (1.8) (9.6) %
Total gross profit $ 63.3 $ 64.8 $ (1.5) (2.3) %
Medical gross margin 28.9 % 29.5 %
Industrial gross margin 37.4 % 43.6 %
Total gross margin 30.8 % 32.6 %
The increase in Medical segment gross profit was primarily due to the increased sales of digital detectors for dental, radiographic, and fluoroscopic modalities, partially offset by increased material costs.
The Industrial segment gross profit decreased primarily as a result of increased material costs, lower service revenue, and an unfavorable shift in product sales mix.
During the first quarter of fiscal year 2023, we experienced a more balanced
operating environment driven by good demand for certain products, an improved
supply chain, and our internal supply chain initiatives. Our product sales mix
for both segments, however, shifted during the quarter and we experienced a
decrease in sales of higher margin, higher-end CT tubes and certain medical
detectors, coupled with lower service revenue from Industrial, which typically
also carries a higher margin profile. We believe this shift was a result of our
customers being cautious in response to an uncertain economic environment and
difficulty in fulfilling backlog due to ongoing supply chain challenges they
face for certain components. These factors contributed to our lower total gross
margin during the quarter.
Operating Expenses
Three Months Ended
(In millions) December 30, 2022 December 31, 2021 $ Change % Change
Research and development $ 20.0 $ 17.7 $ 2.3 13.0 %
As a percentage of total revenues 9.7 % 8.9 %
Selling, general and administrative $ 30.3 $ 33.1 $ (2.8) (8.5) %
As a percentage of total revenues 14.7 % 16.6 %
Operating expenses $ 50.3 $ 50.8$ (0.5) (1.0) % As a percentage of total revenues 24.5 % 25.6 % Research and Development We are committed to investing in the business to support long-term growth and believe long-term research and development expenses of approximately 8% to 10% of annual revenues is the appropriate range that will allow us to innovate and bring new products to market for our global OEM customers. Research and development costs increased to 9.7% of revenues for the first quarter of fiscal year 2023, primarily due to increased spending on labor and material costs supporting research and development initiatives.
Selling, General and Administrative
Selling, general and administrative expenses for the first quarter of fiscal
year 2023 decreased
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Interest and Other Expense, Net
The following table summarizes the Company's interest and other expense, net:
Three Months Ended
(In millions) December 30, 2022 December 31, 2021 $ Change
Interest income $ 0.5 $ - $ 0.5
Interest expense (7.5) (9.9) 2.4
Other expense, net (0.6) (0.8) 0.2
Interest and other expense, net $ (7.6) $
(10.7)
Interest and other expense, net decreased in the first quarter of fiscal year 2023 compared to the first quarter of 2022. Interest expense decreased due to the redemption of$27 million of our Senior Secured Notes inMarch 2022 , reduced fees on the ABL Facility agreement, and reduced interest expense due to the adoption of ASU 2020-06. See Note 1, Summary of Significant Accounting Policies, "Recently Adopted Accounting Pronouncements" for further details concerning the adoption of ASU 2020-06. Other expense, net decreased due to increased income in certain investments in privately-held companies and equity investments, partially offset by increased foreign exchange expense. Interest income increased primarily due to an increase in investments made into marketable debt securities. Taxes on Income For the three months endedDecember 30, 2022 we recognized income tax expense of$2.2 million on$5.4 million of pre-tax income. For the three months endedDecember 31, 2021 we recognized income tax expense of$1.7 million on$3.3 million of pre-tax income. Our tax expense for the three months endedDecember 30, 2022 increased primarily due to increased pre-tax income in certain jurisdictions, valuation allowance positions inthe United States on deferred tax attributes, and losses in certain foreign jurisdictions for which no benefit can be recorded.
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 believe that our operating cash flow, cash on our balance sheet and availability under our ABL Facility are sufficient to meet our anticipated operating cash needs for at least the next 12 months and will be sufficient to allow us to continue to invest in our existing businesses, consummate strategic acquisitions and manage our capital structure on a short and long-term basis. We are currently not aware of any trends or demands, commitments, events, or uncertainties that will result in or that are reasonably likely to result in our liquidity increasing or decreasing in any material way that will impact our capital needs during or beyond the next 12 months. The maximum availability under our ABL Facility is$100.0 million ; however, the borrowing base under the ABL Facility fluctuates from month-to-month depending on the amount of eligible accounts receivable, inventory, and real estate. As ofDecember 30, 2022 the amount available under our ABL Facility was$92.0 million , and the ABL Facility remains undrawn. See Part II, Item 1A - "Risk Factors" for a further discussion. AtDecember 30, 2022 we had total debt of$442.9 million net of discounts and deferred issuance costs of$6.8 million .
Cash and Cash Equivalents, Certificates of
The following table summarizes our cash and cash equivalents, certificates of deposit and marketable securities:
September 30,
(In millions) December 30, 2022 2022 $ Change
Cash and cash equivalents $ 81.5 $ 89.4 $ (7.9)
Certificates of deposit not included in cash and
cash equivalents 7.1 7.2 (0.1)
Marketable securities not included in cash and
cash equivalents 19.1 16.7 2.4
Total $ 107.7 $ 113.3 $ (5.6)
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Borrowings
The following table summarizes the changes in our debt outstanding:
September 30,
December 30, 2022 2022
(In millions, except for percentages) Amount Amount $ Change
Current maturities of long-term debt
Other debt $ 2.1
$ 2.1 $ -
Non-current maturities of long-term debt:
Convertible Senior Unsecured Notes $ 200.0$ 200.0 $ - Senior Secured Notes 243.0 243.0 - Other debt 4.6 4.6 - Total non-current maturities of long-term debt: $ 447.6
Unamortized issuance costs and debt discounts Unamortized discount - Convertible Notes(1) $ -$ (28.7) $ 28.7 Unamortized issuance costs - Convertible Notes(1) (3.5) (3.1) (0.4) Unamortized issuance costs - Senior Secured Notes (3.3) (3.5) 0.2 Total $ (6.8)$ (35.3) $ 28.5 Total debt outstanding, net $ 442.9$ 414.4 $ 28.5 (1) In connection with the adoption of ASU 2020-06, the unamortized discount related to the Convertible Notes was derecognized and the carrying value of the issuance costs was adjusted in the first quarter of fiscal year 2023. Refer to Note 1, Summary of Significant Accounting Policies for further details.
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