Varex Imaging(VREX) - 2023 Q1 - Quarterly Report

PART I. FINANCIAL INFORMATION This part presents Varex Imaging Corporation's unaudited financial statements and management's discussion and analysis of financial condition and results of operations Item 1. Unaudited Financial Statements This section presents Varex Imaging Corporation's unaudited condensed consolidated financial statements for the three months ended December 30, 2022, and December 31, 2021, including statements of operations, comprehensive income, balance sheets, stockholders' equity, and cash flows, along with detailed notes on significant accounting policies, revenue disaggregation, leases, related-party transactions, restructuring, financial derivatives, fair value measurements, inventories, goodwill, intangible assets, borrowings, noncontrolling interests, net income per share, employee stock plans, taxes on income, and segment information Condensed Consolidated Statements of Operations The Condensed Consolidated Statements of Operations show Varex's financial performance for the three months ended December 30, 2022, compared to December 31, 2021, highlighting an increase in net revenues and net income attributable to Varex, despite a slight decrease in gross profit Condensed Consolidated Statements of Operations (in millions) | Metric (in millions) | Dec 30, 2022 | Dec 31, 2021 | Change ($) | Change (%) | | :------------------- | :----------- | :----------- | :--------- | :--------- | | Revenues, net | $205.6 | $198.8 | $6.8 | 3.4% | | Gross profit | $63.3 | $64.8 | $(1.5) | (2.3)% | | Operating income | $13.0 | $14.0 | $(1.0) | (7.1)% | | Net income | $3.2 | $1.6 | $1.6 | 100.0% | | Net income attributable to Varex | $3.1 | $1.4 | $1.7 | 121.4% | | Basic EPS | $0.08 | $0.04 | $0.04 | 100.0% | | Diluted EPS | $0.08 | $0.03 | $0.05 | 166.7% | Condensed Consolidated Statements of Comprehensive Income The Condensed Consolidated Statements of Comprehensive Income show an increase in total comprehensive income attributable to Varex, primarily driven by higher net income, with foreign currency translation adjustments having a minor impact Condensed Consolidated Statements of Comprehensive Income (in millions) | Metric (in millions) | Dec 30, 2022 | Dec 31, 2021 | Change ($) | Change (%) | | :------------------- | :----------- | :----------- | :--------- | :--------- | | Net income | $3.2 | $1.6 | $1.6 | 100.0% | | Foreign currency translation adjustments | — | $(0.5) | $0.5 | - | | Total comprehensive income | $3.2 | $1.1 | $2.1 | 190.9% | | Comprehensive income attributable to Varex | $3.1 | $0.9 | $2.2 | 244.4% | Condensed Consolidated Balance Sheets The Condensed Consolidated Balance Sheets show a slight decrease in total assets and total stockholders' equity from September 30, 2022, to December 30, 2022, while total liabilities increased Condensed Consolidated Balance Sheets (in millions) | Metric (in millions) | Dec 30, 2022 | Sep 30, 2022 | Change ($) | Change (%) | | :------------------- | :----------- | :----------- | :--------- | :--------- | | Total current assets | $607.3 | $609.9 | $(2.6) | (0.4)% | | Total assets | $1,180.9 | $1,184.4 | $(3.5) | (0.3)% | | Total current liabilities | $157.4 | $173.1 | $(15.7) | (9.1)% | | Total liabilities | $655.9 | $637.7 | $18.2 | 2.9% | | Total stockholders' equity | $525.0 | $546.7 | $(21.7) | (4.0)% | - Cash and cash equivalents decreased by $7.9 million from $89.4 million at September 30, 2022, to $81.5 million at December 30, 2022. Inventories increased by $17.1 million, from $303.2 million to $320.3 million[15] Condensed Consolidated Statements of Stockholders' Equity The Condensed Consolidated Statements of Stockholders' Equity show a decrease in total Varex stockholders' equity from September 30, 2022, to December 30, 2022, primarily due to a cumulative effect of an accounting change, partially offset by net income and share-based compensation Condensed Consolidated Statements of Stockholders' Equity (in millions) | Metric (in millions) | Sep 30, 2022 | Dec 30, 2022 | Change ($) | | :------------------- | :----------- | :----------- | :--------- | | Total Varex Stockholders' Equity | $533.4 | $511.7 | $(21.7) | | Noncontrolling Interests | $13.3 | $13.3 | $0.0 | | Total Stockholders' Equity | $546.7 | $525.0 | $(21.7) | - A cumulative effect of an accounting change (ASU 2020-06 adoption) reduced additional paid-in capital by $34.6 million and increased retained earnings by $6.5 million, resulting in a net decrease of $28.1 million in Varex stockholders' equity[16][56] Condensed Consolidated Statements of Cash Flows The Condensed Consolidated Statements of Cash Flows indicate a net decrease in cash and cash equivalents for the three months ended December 30, 2022, primarily due to cash used in operating and investing activities, contrasting with a net increase in the prior year period Condensed Consolidated Statements of Cash Flows (in millions) | Cash Flow Activity (in millions) | Dec 30, 2022 | Dec 31, 2021 | Change ($) | | :------------------------------- | :----------- | :----------- | :--------- | | Operating activities | $(3.7) | $10.8 | $(14.5) | | Investing activities | $(3.7) | $(2.6) | $(1.1) | | Financing activities | $(0.4) | $5.0 | $(5.4) | | Net (decrease) increase in cash | $(7.8) | $13.1 | $(20.9) | - The decrease in cash from operating activities was primarily due to reduced collections from accounts receivable and reduced payments for accounts payable, partially offset by decreased inventory purchases[160] - Investing activities used more cash due to purchases of marketable equity and debt securities, partially offset by the settlement of net investment hedges[161] Notes to the Condensed Consolidated Financial Statements This section provides detailed disclosures and explanations for the unaudited condensed consolidated financial statements, covering significant accounting policies, revenue recognition, lease accounting, related-party transactions, restructuring charges, financial derivatives, fair value measurements, inventory valuation, goodwill and intangible assets, debt obligations, noncontrolling interests, earnings per share calculations, employee stock plans, income taxes, and segment-specific financial information 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES This note outlines Varex's business description, basis of financial statement presentation, reclassification of prior period amounts, segment reporting, fiscal year definition, use of estimates, impact of COVID-19, and policies for cash, restricted cash, concentration of risk, investments, marketable securities, loss contingencies, product warranty, leases, and revenue recognition. It also details the adoption of ASU 2020-06, which significantly impacted the accounting for convertible instruments - Varex designs, manufactures, sells, and services X-ray imaging components for medical and industrial applications, including X-ray tubes, digital detectors, and software[20][21] - The Company adopted ASU 2020-06 on October 1, 2022, using the modified retrospective method, which reduced additional paid-in capital by $34.6 million and increased long-term debt by $28.0 million, impacting interest expense recognition for Convertible Notes[56] Accrued Product Warranty (in millions) | Metric | Dec 30, 2022 | Dec 31, 2021 | | :----- | :----------- | :----------- | | Beginning balance | $7.9 | $8.5 | | New accruals | $2.8 | $1.2 | | Expenditures | $(3.0) | $(2.5) | | Ending balance | $7.7 | $7.2 | 2. REVENUE This note disaggregates Varex's revenue by geographic region and provides details on contract balances, including contract assets and refund liabilities, and the recognition of deferred revenue Revenue by Geographic Region (in millions) | Region | Dec 30, 2022 | Dec 31, 2021 | | :------ | :----------- | :----------- | | Americas | $74.8 | $60.5 | | EMEA | $64.0 | $67.4 | | APAC | $66.8 | $70.9 | | Total | $205.6 | $198.8 | Contract Balances (in millions) | Metric | Dec 30, 2022 | Dec 31, 2021 | | :----------------- | :----------- | :----------- | | Contract Assets (end of period) | $25.4 | $24.6 | | Refund Liabilities (end of period) | $28.3 | $27.3 | - Revenue recognized from deferred revenues existing at the beginning of the period was $4.2 million for the three months ended December 30, 2022, and $4.1 million for the three months ended December 31, 2021[60] 3. LEASES This note details Varex's operating and finance leases, including their balance sheet classification and associated costs and cash flows Lease Information (in millions) | Metric | Dec 30, 2022 | Sep 30, 2022 | | :----- | :----------- | :----------- | | Operating lease ROU assets | $22.1 | $23.2 | | Current operating lease liabilities | $3.9 | $4.0 | | Non-current operating lease liabilities | $17.9 | $18.0 | Lease Costs and Cash Flows (in millions) | Metric | Dec 30, 2022 | Dec 31, 2021 | | :----- | :----------- | :----------- | | Total operating lease costs | $1.5 | $2.0 | | Total finance lease costs | $0.1 | $0.1 | | Operating cash flows from operating leases | $1.6 | $1.9 | | Financing cash flows from finance leases | $0.1 | $0.1 | 4. RELATED-PARTY TRANSACTIONS This note describes Varex's investments in privately-held companies, specifically dpiX Holding LLC and VEC Imaging GmbH & Co. KG, detailing ownership interests, equity method accounting, and transactions such as purchases and loans - Varex holds a 40% ownership interest in dpiX Holding LLC, a supplier of amorphous silicon-based thin film transistor arrays, accounted for under the equity method[63][64] Income (Loss) on Equity Investment in dpiX Holding (in millions) | Period | Amount | | :----------- | :----- | | Dec 30, 2022 | $2.0 | | Dec 31, 2021 | $(0.7) | - Varex purchased $5.0 million and $5.2 million in glass transistor arrays from dpiX for the three months ended December 30, 2022, and December 31, 2021, respectively[65] - Varex has a fixed cost commitment of $13.1 million for calendar year 2023 to dpiX, representing 50% of dpiX's fixed costs[67] - Varex also holds an equity investment in VEC Imaging GmbH & Co. KG, recording a loss of $0.3 million and $0.1 million for the three months ended December 30, 2022, and December 31, 2021, respectively[69][70] 5. RESTRUCTURING This note outlines restructuring charges incurred by Varex, primarily related to the relocation of amorphous silicon glass production and the closure of its Santa Clara facility, predominantly impacting the Medical segment - Restructuring charges predominantly relate to the Medical segment, stemming from the relocation of amorphous silicon glass production and the closure of the Santa Clara facility[71][72] Restructuring Charges (in millions) | Charge Type | Dec 30, 2022 | Dec 31, 2021 | | :---------------------- | :----------- | :----------- | | Other assets impairment | $— | $1.8 | 6. FINANCIAL DERIVATIVES AND HEDGING ACTIVITIES This note describes Varex's use of financial derivatives, specifically cross currency swap contracts, to manage foreign currency exchange rate and interest rate exposures, including their fair value accounting and designation as net investment hedges - Varex uses cross currency swap contracts as net investment hedges to manage foreign currency risk, with changes in fair value reported in accumulated other comprehensive income[76] - During the three months ended December 30, 2022, Varex terminated all three previously outstanding cross currency swap contracts, resulting in $7.3 million cash received upon settlement, and entered into two new cross currency swaps with a notional value of $58.7 million[76][77] Derivative Assets and Liabilities (in millions) | Balance Sheet Location | Dec 30, 2022 | Sep 30, 2022 | | :--------------------- | :----------- | :----------- | | Prepaid expenses and other current assets (Derivative assets) | $1.1 | $1.2 | | Other assets (Derivative assets) | $— | $6.3 | | Other long-term liabilities (Derivative liabilities) | $4.7 | $— | 7. FAIR VALUE This note provides information on the fair value measurements of Varex's financial instruments, including marketable securities and derivatives, categorized by the fair value hierarchy (Level 1, 2, and 3 inputs) Assets Measured at Fair Value (in millions) - Dec 30, 2022 | Asset Type | Level 1 | Level 2 | Level 3 | Total | | :--------------------- | :------ | :------ | :------ | :---- | | Money market funds | $— | $21.5 | $— | $21.5 | | Commercial paper | $— | $4.9 | $— | $4.9 | | Corporate notes/bonds | $— | $3.6 | $— | $3.6 | | U.S. Treasury bills | $— | $10.3 | $— | $10.3 | | Derivative assets | $— | $1.1 | $— | $1.1 | | Marketable equity securities | $4.5 | $— | $— | $4.5 | | Total | $10.3 | $41.7 | $— | $52.0 | Marketable Debt Securities (in millions) - Dec 30, 2022 | Type | Amortized Costs | Unrealized Losses | Fair Value | | :-------------------- | :-------------- | :---------------- | :--------- | | Commercial paper | $4.9 | $— | $4.9 | | Corporate notes/bonds | $3.7 | $(0.1) | $3.6 | | U.S. Treasury bills | $10.3 | $— | $10.3 | | Government agencies | $0.3 | $— | $0.3 | | Total | $19.2 | $(0.1) | $19.1 | - The fair values of Convertible Notes and Senior Secured Notes (Level 1 inputs) were $229.0 million and $239.3 million, respectively, as of December 30, 2022[79] 8. INVENTORIES This note provides a breakdown of Varex's inventories by raw materials and parts, work-in-process, and finished goods Inventories (in millions) | Category | Dec 30, 2022 | Sep 30, 2022 | | :---------------- | :----------- | :----------- | | Raw materials and parts | $247.5 | $240.3 | | Work-in-process | $25.1 | $23.2 | | Finished goods | $47.7 | $39.7 | | Total inventories | $320.3 | $303.2 | 9. GOODWILL AND INTANGIBLE ASSETS This note presents the goodwill by reportable operating segment and the gross carrying amount, accumulated amortization, and net carrying amount of finite-lived intangible assets Goodwill by Segment (in millions) | Segment | Sep 30, 2022 | Dec 30, 2022 | | :-------- | :----------- | :----------- | | Medical | $169.4 | $171.6 | | Industrial | $115.1 | $116.6 | | Total | $284.5 | $288.2 | Finite-Lived Intangible Assets (in millions) - Dec 30, 2022 | Category | Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | | :------------------------ | :-------------------- | :----------------------- | :------------------ | | Acquired existing technology | $71.5 | $(52.3) | $19.2 | | Patents, licenses and other | $12.5 | $(11.8) | $0.7 | | Customer contracts and supplier relationship | $50.3 | $(38.5) | $11.8 | | Total intangible assets | $134.3 | $(102.6) | $31.7 | - Amortization expense for intangible assets was $3.4 million for the three months ended December 30, 2022, down from $3.8 million in the prior year period[86] 10. BORROWINGS This note details Varex's short-term and long-term debt, including Convertible Senior Unsecured Notes and Senior Secured Notes, interest expense, and the terms of its Asset-Based Loan (ABL) Facility Debt Outstanding (in millions) | Debt Type | Dec 30, 2022 | Sep 30, 2022 | Contractual Interest Rate | | :------------------------ | :----------- | :----------- | :------------------------ | | Convertible Senior Unsecured Notes | $200.0 | $200.0 | 4.0% | | Senior Secured Notes | $243.0 | $243.0 | 7.9% | | Total debt outstanding, net | $442.9 | $414.4 | - | Interest Expense (in millions) | Category | Dec 30, 2022 | Dec 31, 2021 | | :------------------------ | :----------- | :----------- | | Contractual interest coupon and other | $6.9 | $7.3 | | Amortization of debt issuance costs | $0.6 | $0.5 | | Amortization of debt discounts | $— | $2.1 | | Total interest expense | $7.5 | $9.9 | - The unamortized discount related to Convertible Notes was derecognized in Q1 FY2023 due to ASU 2020-06 adoption, reducing interest expense[88][56] - The ABL Facility has a maximum availability of $100.0 million, with $92.0 million available and undrawn as of December 30, 2022[96] 11. NONCONTROLLING INTERESTS This note details Varex's noncontrolling interests in its Saudi Arabia partnership and MeVis Medical Solutions AG, including ownership percentages and the allocation of net income - Varex has a 75% interest in a Saudi Arabia partnership, consolidating its operations and recording noncontrolling interests for the partner's 25% share[98] - Varex owns 73.7% of MeVis Medical Solutions AG, with noncontrolling shareholders holding 26.3% and receiving an annual net compensation of €0.95 per share[99] Changes in Noncontrolling Interests (in millions) | Metric | Dec 30, 2022 | Dec 31, 2021 | | :----- | :----------- | :----------- | | Beginning balance | $13.3 | $13.2 | | Net income attributable to noncontrolling interests | $0.1 | $0.2 | | Ending balance | $13.3 | $13.3 | 12. NET INCOME PER SHARE This note provides a reconciliation of the numerator and denominator used in calculating basic and diluted net income per common share, highlighting the impact of potentially dilutive securities and the adoption of ASU 2020-06 Net Income Per Share (in millions, except per share amounts) | Metric | Dec 30, 2022 | Dec 31, 2021 | | :----- | :----------- | :----------- | | Net income attributable to Varex | $3.1 | $1.4 | | Basic weighted average shares outstanding | 40.1 | 39.5 | | Basic net income per share | $0.08 | $0.04 | | Diluted weighted average shares outstanding | 40.6 | 43.9 | | Diluted net income per share | $0.08 | $0.03 | - The adoption of ASU 2020-06 on October 1, 2022, requires the use of the if-converted method for Convertible Notes, assuming conversion into 9.6 million shares for diluted EPS calculation, if dilutive[103] Anti-Dilutive Share Summary (in millions) | Category | Dec 30, 2022 | Dec 31, 2021 | | :---------------- | :----------- | :----------- | | Restricted stock and options | 3.0 | 2.5 | | Convertible notes | 9.6 | — | | Warrants | 1.9 | — | | Total anti-dilutive shares | 14.5 | 2.5 | 13. EMPLOYEE STOCK PLANS This note summarizes Varex's share-based compensation expense and activity for stock options, restricted stock units, restricted stock awards, and deferred stock units under its employee incentive plans Share-Based Compensation Expense (in millions) | Category | Dec 30, 2022 | Dec 31, 2021 | | :------------------------ | :----------- | :----------- | | Cost of revenues | $0.4 | $0.4 | | Research and development | $0.8 | $0.8 | | Selling, general and administrative | $2.1 | $2.2 | | Total | $3.3 | $3.4 | Stock Option Activity (in thousands, except per share amounts) | Metric | Options | Weighted Average Exercise Price | | :------------------------ | :------ | :------------------------------ | | Outstanding at Sep 30, 2022 | 2,902 | $28.97 | | Granted | 385 | $22.13 | | Canceled, expired or forfeited | (196) | $31.44 | | Outstanding at Dec 30, 2022 | 3,091 | $27.96 | | Exercisable at Dec 30, 2022 | 2,070 | $29.52 | Restricted Stock Units, Awards, and Deferred Stock Units Activity (in thousands) | Metric | Number of Shares | Weighted Average Grant-Date Fair Value | | :------------------------ | :--------------- | :------------------------------------- | | Outstanding at Sep 30, 2022 | 1,045 | $24.35 | | Granted | 492 | $20.12 | | Vested | (3) | $23.70 | | Canceled or expired | (28) | $25.50 | | Outstanding at Dec 30, 2022 | 1,506 | $22.95 | 14. TAXES ON INCOME This note details Varex's income tax expense, its drivers, and the company's reinvestment assertion regarding foreign earnings Income Tax Expense (in millions) | Period | Pre-Tax Income | Income Tax Expense | | :----------- | :------------- | :----------------- | | Dec 30, 2022 | $5.4 | $2.2 | | Dec 31, 2021 | $3.3 | $1.7 | - The increase in tax expense for the three months ended December 30, 2022, was primarily due to increased pre-tax income in certain jurisdictions, valuation allowance positions in the U.S. on deferred tax attributes, and unbenefited losses in some foreign jurisdictions[109] - Varex maintains a reinvestment assertion for foreign earnings prior to fiscal year 2018 and for Direct Conversion earnings, with a deferred tax liability of approximately $0.1 million for potential repatriation of post-FY2017 earnings in other countries[110] 15. SEGMENT INFORMATION This note provides financial information for Varex's two reportable operating segments: Medical and Industrial, detailing their respective revenues and gross profits - Varex operates in two reportable segments: Medical (X-ray imaging components for medical applications) and Industrial (X-ray imaging products for security, inspection, and non-destructive testing)[112][113] Segment Revenues and Gross Profit (in millions) | Segment | Dec 30, 2022 Revenues | Dec 31, 2021 Revenues | Dec 30, 2022 Gross Profit | Dec 31, 2021 Gross Profit | | :-------- | :-------------------- | :-------------------- | :------------------------ | :------------------------ | | Medical | $160.1 | $155.7 | $46.3 | $46.0 | | Industrial | $45.5 | $43.1 | $17.0 | $18.8 | | Total | $205.6 | $198.8 | $63.3 | $64.8 | Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides Varex's management's perspective on the company's financial condition and results of operations for the three months ended December 30, 2022, compared to the prior year. It covers an overview of the business, the impact of macroeconomic factors like COVID-19 and inflation, detailed segment performance, critical accounting policies, and an analysis of liquidity and capital resources Overview Varex Imaging Corporation is a leading innovator, designer, and manufacturer of X-ray imaging components for medical diagnostic imaging, security inspection, and industrial quality inspection systems, with a global presence and a focus on R&D and customer relationships - Varex is a leading innovator, designer, and manufacturer of X-ray imaging components, including tubes, digital detectors, linear accelerators, and image software processing solutions[123] - The company's products are used in medical diagnostic imaging, security inspection systems, and industrial quality inspection systems[123] - Varex has approximately 2,300 full-time equivalent employees across North America, Europe, and Asia, and invests in R&D with approximately 300 individuals in product development[123][125] Impact of COVID-19, Inflation and the General Economic Environment Varex continues to face challenges from the COVID-19 pandemic, including supply chain disruptions, material shortages (especially micro-controller chips), increased costs due to inflation, and logistics issues, despite a recovery in demand for many products. The company has implemented price increases to mitigate rising costs - Varex continues to experience supply chain, manufacturing, and logistics challenges, including shortages of micro-controller chips and electronic components, expected to persist into 2023[128] - Inflation has increased costs, leading Varex to raise prices on certain products in fiscal year 2022 and anticipate further adjustments in fiscal year 2023[127][128] - Demand for products recovered to pre-pandemic levels in fiscal year 2022 due to increased healthcare investments and deferred capital purchases, but supply chain interruptions limit conversion of demand to sales[127][136] Operating Segments and Products Varex operates in Medical and Industrial segments. The Medical segment focuses on X-ray imaging components for various medical applications, benefiting from long-term OEM relationships and replacement demand. The Industrial segment provides X-ray imaging products for security and non-destructive testing, leveraging R&D from the Medical side for higher gross profit Medical The Medical segment designs and manufactures X-ray imaging components for medical applications, primarily selling to OEMs with strong, long-term relationships due to customized products and regulatory requirements. Replacement and service of the large installed base contribute significantly to revenue, with varying replacement cycles for different products. The segment faces ongoing supply chain interruptions but sees growth opportunities in China's expanding healthcare market - Medical segment products include X-ray tubes, digital detectors, and image-processing software for CT, mammography, oncology, cardiac, surgery, dental, and other diagnostic radiography uses[132] - Varex is one of the largest global manufacturers, producing over 28,000 X-ray tubes and 20,000 X-ray detectors annually, with an installed base of over 160,000 X-ray tubes and 170,000 X-ray detectors[135] - The company is expanding manufacturing capabilities in China, Germany, the Netherlands, and the Philippines, and implementing local sourcing strategies to mitigate trade war impacts and supply chain disruptions[138] Industrial The Industrial segment develops X-ray imaging products for security (cargo and baggage screening) and non-destructive testing (aerospace, automotive, electronics). It benefits from R&D and economies of scale from the Medical business, achieving higher gross profit margins and long-term service agreements. Demand in this segment is influenced by government policies and economic conditions, showing improved conditions in Q1 FY2023 - Industrial segment products include Linatron® X-ray linear accelerators, X-ray tubes, digital detectors, high voltage connectors, and coolers for security and non-destructive testing applications[139] - The Industrial business generally achieves higher gross profit for its products relative to the Medical business due to R&D investment and manufacturing economies of scale[139] - Demand for industrial products, particularly in non-destructive testing and security markets, has shown improved conditions during the three months ended December 30, 2022[142] Critical Accounting Policies and Estimates This section highlights Varex's critical accounting policies and estimates that require significant management judgment, including the valuation of inventories, goodwill and intangible assets, and income taxes. No material changes occurred, except for the adoption of ASU 2020-06 - Critical accounting policies include valuation of inventories, assessment of recoverability of goodwill and intangible assets, and income taxes, which require significant management judgment[143][144] - No material changes to significant accounting policies were made, except for the adoption of ASU 2020-06, as detailed in Note 1[144] Fiscal Year Varex's fiscal year is a 52 or 53-week period ending on the Friday nearest September 30. Fiscal year 2023 ends on September 29, 2023, and the reported fiscal quarters were both 13-week periods - Varex's fiscal year is a 52 or 53-week period ending on the Friday nearest September 30[145] - The fiscal quarters ended December 30, 2022, and December 31, 2021, were both 13-week periods[145] Discussion of Results of Operations for the Three Months Ended December 30, 2022 Compared to the Three Months Ended December 31, 2021 This section provides a comparative analysis of Varex's financial performance for the three months ended December 30, 2022, versus December 31, 2021, detailing changes in revenues, gross profit, operating expenses, interest and other expenses, and taxes on income Revenues, net Net revenues increased by 3.4% year-over-year, driven by growth in both Medical and Industrial segments, with Medical revenues increasing due to digital detectors and Industrial revenues from dynamic imaging applications Revenues, net (in millions) | Segment | Dec 30, 2022 | Dec 31, 2021 | $ Change | % Change | | :-------- | :----------- | :----------- | :------- | :------- | | Medical | $160.1 | $155.7 | $4.4 | 2.8% | | Industrial | $45.5 | $43.1 | $2.4 | 5.6% | | Total | $205.6 | $198.8 | $6.8 | 3.4% | - Medical revenues increased primarily due to increased sales of digital detectors for dental, radiographic, and fluoroscopic modalities, partially offset by lower oncology sales[146] - Industrial revenues increased primarily due to increased sales of digital detectors for dynamic imaging applications, partially offset by lower sales of security inspection products[147] Gross Profit Total gross profit decreased by 2.3% year-over-year, with Medical gross profit slightly increasing due to higher sales, but Industrial gross profit declining significantly due to increased material costs, lower service revenue, and an unfavorable product sales mix Gross Profit (in millions) | Segment | Dec 30, 2022 | Dec 31, 2021 | $ Change | % Change | | :-------- | :----------- | :----------- | :------- | :------- | | Medical | $46.3 | $46.0 | $0.3 | 0.7% | | Industrial | $17.0 | $18.8 | $(1.8) | (9.6)% | | Total | $63.3 | $64.8 | $(1.5) | (2.3)% | Gross Margin | Segment | Dec 30, 2022 | Dec 31, 2021 | | :-------- | :----------- | :----------- | | Medical | 28.9% | 29.5% | | Industrial | 37.4% | 43.6% | | Total | 30.8% | 32.6% | - Industrial segment gross profit decreased primarily due to increased material costs, lower service revenue, and an unfavorable shift in product sales mix, including decreased sales of higher-margin CT tubes and certain medical detectors[149][150] Operating Expenses Total operating expenses slightly decreased year-over-year, with a significant increase in Research and Development expenses offset by a decrease in Selling, General and Administrative expenses Operating Expenses (in millions) | Category | Dec 30, 2022 | Dec 31, 2021 | $ Change | % Change | | :------------------------ | :----------- | :----------- | :------- | :------- | | Research and development | $20.0 | $17.7 | $2.3 | 13.0% | | Selling, general and administrative | $30.3 | $33.1 | $(2.8) | (8.5)% | | Total operating expenses | $50.3 | $50.8 | $(0.5) | (1.0)% | Research and Development Research and development costs increased to 9.7% of revenues, primarily due to higher spending on labor and material costs for R&D initiatives, reflecting a commitment to long-term growth - Research and development costs increased by $2.3 million (13.0%) to $20.0 million, representing 9.7% of total revenues[151][152] - The increase was primarily due to increased spending on labor and material costs supporting research and development initiatives[152] Selling, General and Administrative Selling, general and administrative expenses decreased due to lower restructuring costs and incentive compensation compared to the prior year, falling to 14.7% of total revenues - Selling, general and administrative expenses decreased by $2.8 million (8.5%) to $30.3 million, representing 14.7% of total revenues[151][153] - The decrease was primarily due to decreased restructuring costs and incentive compensation compared to the prior year[153] Interest and Other Expense, Net Interest and other expense, net, decreased significantly year-over-year, driven by lower interest expense due to debt redemption and accounting changes, and increased interest income from marketable debt securities Interest and Other Expense, Net (in millions) | Category | Dec 30, 2022 | Dec 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) | $3.1 | - Interest expense decreased due to the redemption of $27 million of Senior Secured Notes in March 2022, reduced ABL Facility fees, and reduced interest expense from the adoption of ASU 2020-06[155] - Interest income increased primarily due to an increase in investments made into marketable debt securities[155] Taxes on Income Income tax expense increased for the three months ended December 30, 2022, primarily due to higher pre-tax income in certain jurisdictions, valuation allowance positions in the U.S., and unbenefited losses in some foreign jurisdictions Income Tax Expense (in millions) | Period | Pre-Tax Income | Income Tax Expense | | :----------- | :------------- | :----------------- | | Dec 30, 2022 | $5.4 | $2.2 | | Dec 31, 2021 | $3.3 | $1.7 | - The increase in tax expense was primarily due to increased pre-tax income in certain jurisdictions, valuation allowance positions in the U.S. on deferred tax attributes, and losses in certain foreign jurisdictions for which no benefit can be recorded[156] Liquidity and Capital Resources Varex assesses its liquidity based on operating cash flow, cash on hand, and ABL Facility availability, which are deemed sufficient for anticipated operating needs and investments for at least the next 12 months. The section details changes in cash, marketable securities, borrowings, and cash flow activities, along with contractual obligations and backlog - Varex believes its operating cash flow, cash on balance sheet, and ABL Facility availability are sufficient to meet anticipated operating cash needs for at least the next 12 months[157] - As of December 30, 2022, the ABL Facility had $92.0 million available and was undrawn[157] Cash and Marketable Securities (in millions) | Category | Dec 30, 2022 | Sep 30, 2022 | $ Change | | :---------------------------------------- | :----------- | :----------- | :------- | | Cash and cash equivalents | $81.5 | $89.4 | $(7.9) | | Certificates of deposit not in cash equivalents | $7.1 | $7.2 | $(0.1) | | Marketable securities not in cash equivalents | $19.1 | $16.7 | $2.4 | | Total | $107.7 | $113.3 | $(5.6) | - Total debt outstanding, net, increased by $28.5 million to $442.9 million as of December 30, 2022, primarily due to the derecognition of the unamortized discount on Convertible Notes following ASU 2020-06 adoption[157][159] - Net cash used in operating activities was $(3.7) million for the three months ended December 30, 2022, a decrease from $10.8 million provided in the prior year, mainly due to reduced accounts receivable collections and accounts payable payments[160] - Total estimated backlog at December 30, 2022, was approximately $405 million[171] Item 3. Quantitative and Qualitative Disclosures About Market Risk This section details Varex's exposure to various market risks, including foreign currency exchange rate risk, credit and counterparty risk, interest rate risk, and commodity price risk, and outlines strategies to mitigate these exposures - Varex is exposed to foreign currency exchange rate risk due to significant international sales, with a strong U.S. Dollar potentially leading to pricing pressure and impacting revenues and expenses[175] - The company uses foreign currency forward and option contracts, and cross-currency swaps, to hedge foreign exchange risks[176] - Varex faces credit and counterparty risk related to cash, marketable securities, and trade accounts receivable, mitigated by ongoing credit evaluations and strong credit controls[177][178] - Interest rate risk primarily relates to interest-bearing assets (cash, marketable securities) and floating-rate borrowings under the ABL Facility (currently undrawn)[179][180] - Varex is exposed to commodity price risk from raw materials like tungsten, lead, iridium, and copper, which can impact product margins, but had no commodity derivative instruments in place during the period[181] Item 4. Controls and Procedures This section confirms the effectiveness of Varex's disclosure controls and procedures as of December 30, 2022, and states that there were no material changes in internal control over financial reporting during the quarter - Varex's disclosure controls and procedures were effective as of December 30, 2022, providing reasonable assurance that required information is recorded, processed, summarized, and reported timely[182] - There were no changes in internal control over financial reporting during the quarter ended December 30, 2022, that materially affected, or are reasonably likely to materially affect, internal control over financial reporting[183] PART II. OTHER INFORMATION This part provides additional information on Varex Imaging Corporation, including legal proceedings, risk factors, equity sales, defaults, and exhibits Item 1. Legal Proceedings Varex is subject to various claims and legal actions in the normal course of business but is not aware of any currently pending litigation that could have a material adverse effect on its operations or financial position - Varex is subject to various claims, complaints, and legal actions in the normal course of business[185] - The company is not aware of any currently pending litigation for which the outcome could have a material adverse effect on its operations or financial position[185] Item 1A. Risk Factors This section outlines the principal risks associated with investing in Varex Imaging Corporation, covering a broad range of potential challenges including global economic instability, geopolitical tensions, customer concentration, intense market competition, technological innovation, international operations, the ongoing impact of COVID-19, talent retention, acquisition risks, product quality and liability, ESG requirements, supply chain disruptions, manufacturing vulnerabilities, intellectual property protection, cybersecurity threats, regulatory compliance (import/export, healthcare, environmental), and risks related to the company's indebtedness and common stock - Key risks include global economic instability, geopolitical tensions, supply chain disruptions, and inflation, which can increase costs and affect demand[190][191][192] - Varex relies on a limited number of OEM customers, with one customer accounting for 20% of revenue and the top ten for 55%, making the company vulnerable to order reductions or loss of business[197] - The company faces intense competition, requiring continuous innovation and cost management, with risks of losing business to competitors or in-house manufacturing by OEMs[201][202] - International operations, which generate over half of Varex's revenue, are subject to currency fluctuations, trade restrictions, political instability, and difficulties in enforcing agreements[208] - Significant debt obligations could limit financial flexibility, increase vulnerability to economic conditions, and require a substantial portion of cash flow for debt payments[289][290] Summary of Principal Risk Factors This section provides a high-level overview of the main risks associated with investing in Varex, including economic instability, customer concentration, competitive markets, product development, international operations, COVID-19 impacts, employee retention, acquisition challenges, warranty and product liability, ESG requirements, manufacturing disruptions, intellectual property, information systems, regulatory changes, and debt obligations - The global economy, geopolitical tensions, and economic instability can adversely affect Varex's business, financial condition, operating results, cash flows, and stock price[187] - Reliance on a limited number of OEM customers, many of whom are also competitors, poses a risk of sales reduction or loss of business[187] - Challenges in attracting and retaining employees, supply chain disruptions, and the successful development and commercialization of new products are critical for future success[187] - Significant debt obligations and restrictive covenants could limit operating flexibility and ability to meet obligations[187] Risks Relating to Our Business This section details risks related to Varex's general business operations, including the adverse effects of global economic instability, geopolitical tensions, inflation, and foreign currency fluctuations on supply chains, costs, and demand. It also highlights the risks associated with customer concentration and the difficulty in predicting product demand - Global economic instability, geopolitical tensions, and inflation have led to supply chain disruptions, material shortages (especially micro-controller chips), increased costs, and shipping delays, impacting Varex's ability to deliver products and potentially leading to production halts[190][191][192] - Fluctuations in foreign currency exchange rates, particularly a strong U.S. Dollar, can create pricing pressure, affect product demand, and impact profitability in foreign markets[193] - Varex's dependence on a limited number of major OEM customers (one customer accounted for 20% of revenue, top ten for 55%) makes it vulnerable to order cancellations, delays, or reductions, which could materially affect operating results[197] We sell our products and services to a limited number of OEM customers, many of which are also our competitors, and a reduction in or loss of business of one or more of these customers may materially reduce our sales. Varex's reliance on a small number of OEM customers, some of whom are also competitors, creates a significant risk. A reduction or loss of business from these major customers could materially decrease sales and adversely affect financial results, especially given the time it takes to replace lost business - One customer accounted for 20% of Varex's revenue for the three months ended December 30, 2022, and the top ten customers accounted for approximately 55%[197] - Many OEM customers also have in-house X-ray component manufacturing, posing a risk if they increase internal production or decrease purchases from Varex[201] - Cancellation, delay, or reduction of orders by major OEM customers could materially and adversely affect operating results due to the significant time required to replace lost business[197] We may not be able to accurately predict the demand or delivery schedules for our products. Varex faces challenges in accurately forecasting product demand and delivery schedules due to external factors like economic uncertainties, the COVID-19 pandemic, and customer-specific issues. Inaccurate predictions can lead to excess inventory, sales slowdowns, and adverse impacts on operating results - External factors such as economic uncertainties, the COVID-19 pandemic, natural disasters, and geopolitical tensions make it difficult to accurately predict product demand and delivery schedules[200] - Changes in customer purchasing forecasts, often on short notice, can lead to excess inventory and slowdowns in sales, materially affecting operating results[200] - Agreements with customers typically rely on forward-looking forecasts rather than firm commitments, and actual purchasing volumes can vary significantly[200] We compete in highly competitive markets, and we may lose business to our customers or other companies with greater resources or with greater abilities to develop more effective technologies, or we could be forced to reduce our prices. Varex operates in highly competitive markets characterized by rapid technological evolution and pricing pressure. The company competes with both major OEM customers who have in-house manufacturing and numerous smaller competitors, necessitating a competitive advantage in cost, quality, or technology to retain business and avoid price reductions - Varex competes in markets with rapidly-evolving technology, intense competition, and pricing pressure, often against companies with greater financial and marketing resources[201] - Major diagnostic imaging systems companies, which are primary OEM customers, also manufacture X-ray imaging components in-house, creating competition for Varex's business[201] - The market for flat panel detectors is highly competitive with over a dozen smaller competitors, requiring Varex to maintain advantages in product cost, quality, or technology[202] Our success depends on the successful development, introduction, and commercialization of new generations of products and enhancements to or simplifications of existing product lines. Varex's success hinges on its ability to continually develop and introduce new products and enhancements in a rapidly changing technological market. Failure to anticipate customer needs, manage R&D costs, comply with regulatory approvals, or protect intellectual property could lead to loss of customers, reduced revenues, and adverse impacts on financial performance - Success depends on continually introducing new products at competitive costs and improving existing products with higher quality, lower costs, and increased features in a rapidly evolving market[205] - Failure to properly identify customer needs, manage R&D costs, or comply with quality assurance and regulatory processes can result in delays, increased expenses, and adverse impacts on financial performance[207] - New products may cannibalize sales of existing products or render them obsolete, and certain costs (e.g., installation, warranty) associated with new products can disproportionately affect gross and operating margins[206] More than half of our revenue is generated from customers located outside the United States, and is subject to global, regional, and country-specific economic instability, shifting political environments, changing tax treatment, and other risks associated with international operations and sales that could materially and adversely affect our business and financial results. Over 60% of Varex's revenue comes from international customers, exposing the company to significant risks including currency fluctuations (especially a strong U.S. Dollar), longer payment cycles, difficulties in legal enforcement, trade restrictions, political and economic instability, and challenges in protecting intellectual property in foreign countries. These factors can materially harm business and financial results - Revenues from customers outside the United States accounted for approximately 64% and 70% of total revenues for the three months ended December 30, 2022, and December 31, 2021, respectively[208] - International operations are subject to risks such as currency fluctuations (strong U.S. Dollar), longer payment cycles, difficulties in enforcing agreements, trade restrictions, political/economic instability, and challenges in protecting intellectual property[208] - Increased dependence on international sales makes Varex more vulnerable to these factors, potentially harming future results[209] COVID-19 has adversely impacted our operations, cash flow, and financial position, and in the future we could continue to be adversely impacted by the COVID-19 pandemic and continuing economic disruptions. The COVID-19 pandemic has significantly impacted Varex's operations, cash flow, and financial position, creating volatility and economic disruption. Ongoing outbreaks, local government lockdowns (especially in China), and a competitive labor market continue to pose risks to manufacturing, sales, service, and talent retention, potentially affecting future operating results - The COVID-19 pandemic has adversely impacted Varex's operations, cash flow, and financial position, creating significant volatility and economic disruption[210] - New or continuing outbreaks, local government lockdowns (e.g., in China), and travel prohibitions could affect manufacturing, sales, service, and customer/supplier relationships[210] - The pandemic has contributed to a tightening and competitive labor market, increasing wages and voluntary attrition, making talent recruitment and retention more difficult[210][211] It has become more difficult to attract and retain employees, which has impacted, and is likely to continue to impact, our ability to develop and manufacture products and operate our business. Varex faces increasing difficulty in attracting and retaining qualified employees, particularly in engineering, service, sales, and manufacturing, due to a competitive labor market and wage inflation. This challenge, exacerbated by the 'Great Resignation,' could hinder product development, manufacturing, and overall business operations - Varex's future success depends on its ability to retain, attract, expand, integrate, and train management and key personnel, including engineering, service, sales, marketing, and manufacturing staff[211] - Competition for qualified personnel has increased, leading to higher compensation-related costs and making recruitment and retention more difficult, especially in regions with low unemployment rates like Utah[211] - The 'Great Resignation' has intensified challenges in employee attraction and retention, and replacing key employees can be difficult, costly, and time-consuming[212] We may face additional risks from the acquisition or development of new lines of business. Acquiring or developing new lines of business presents substantial risks for Varex, especially in undeveloped or unfamiliar markets. Challenges include gaining expertise, recruiting professionals, increased liability exposure, higher R&D costs, and managing new relationships. Failure to manage these risks could materially and adversely affect business and financial results - New lines of business involve substantial risks and uncertainties, particularly in undeveloped or unfamiliar markets, including developing expertise, recruiting professionals, and managing new relationships[213] - Risks include increased liability exposure, higher research and development expenditures, and potential failure to achieve integration timelines or profitability targets, as new products may have lower gross margins[213] - Demand for multi-purpose products in new and emerging industries may be negatively impacted by varying, inconsistent, and rapidly changing laws, regulations, and consumer perceptions[214] We may be unable to complete future acquisitions or realize expected benefits from acquisitions of or investments in new businesses, products, or technologies, which could harm our business. Varex's growth strategy includes acquisitions, but identifying suitable candidates, completing transactions, and successfully integrating acquired entities are challenging. Acquisitions can divert management resources, incur significant costs, and may not yield expected synergies or returns, potentially leading to impairment losses or dilutive equity issuances - Identifying suitable acquisition candidates is difficult, time-consuming, and costly, and Varex may fail to complete or finance identified acquisitions, impairing growth[216] - Integrating acquisitions can be expensive, time-consuming, and strain resources, potentially increasing R&D expenses, litigation risk, and difficulty retaining employees or customers of acquired companies[217] - Failure to achieve anticipated growth from an acquisition could lead to impairment losses on assets and goodwill, adversely affecting financial results[219] - Investments in joint ventures and privately-held companies (e.g., dpiX LLC, VEC Imaging GmbH & Co. KG) carry risks of capital loss and may not yield expected returns[220] Warranty claims may materially and adversely affect our business. An increase in warranty claims due to product quality issues or failures could damage Varex's market reputation, reduce sales, and necessitate costly repairs or remedial measures. If actual claims exceed estimates, cost of sales could increase, materially affecting financial condition and profitability - An increase in warranty claims due to product quality issues or failures could damage market reputation, cause sales to decline, or require costly repairs/remedial measures[221] - If actual warranty claims are greater than estimated, cost of sales could increase, materially and adversely affecting financial condition[221] - A shift in product mix towards categories with higher warranty claims could lead to an overall increase in claims[221] 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 revenues and require us to pay material uninsured claims. Varex faces significant product liability risks due to its components being used in medical devices and radiation-emitting systems. Defects or misus