Varex Imaging Corporation — FY2018 Form 10-K
Reporting period: Fiscal year ended September 28, 2018 (52 weeks). The filing also reports fourth-quarter results. Varex designs and manufactures X-ray imaging components for medical and industrial applications; it reports Medical and Industrial segments.
Financial performance and liquidity
| Metric | FY2018 | FY2017 |
|---|---|---|
| Revenue | $773.4 million | $698.1 million |
| Gross profit / margin | $253.9 million / 32.8% | $253.5 million / 36.3% |
| Operating earnings | $44.5 million | $83.7 million |
| Net earnings attributable to Varex | $27.5 million; $0.72 diluted EPS | $51.6 million; $1.36 diluted EPS |
| Operating cash flow | $85.3 million | $74.6 million |
| Cash and cash equivalents | $51.9 million | $83.3 million |
| Working capital | $306.1 million | $343.5 million |
| Debt, net of issuance costs | $389.8 million | $483.9 million |
FY2018 investing cash outflow was $25.8 million, including $20.4 million of capital expenditures and a $4.8 million acquisition. Financing cash outflow was $90.4 million, mainly reflecting $106.0 million of debt repayments. The company reported $172.0 million of revolving-credit availability at year-end; it subsequently reduced the facility commitment by $50.0 million, effective October 10, 2018. The filing reports no cash dividends and no current plan to pay them.
Fourth quarter: Revenue was $204.8 million versus $215.7 million in FY2017 Q4; gross profit was $59.3 million versus $77.8 million; net earnings were $0.7 million versus $15.1 million. The filing’s quarterly table reports diluted EPS of $0.01 versus $0.39.
Changes and drivers
- Annual revenue increased 11%: Medical revenue rose 8% to $602.0 million and Industrial revenue rose 21% to $171.4 million. The acquired PerkinElmer detector business contributed to growth.
- Gross profit was nearly unchanged despite higher revenue, and gross margin fell to 32.8% from 36.3%. Management cited lower-margin product mix, $7.3 million of restructuring charges including $3.1 million of inventory markdowns, higher digital-detector costs at Santa Clara, and tariffs affecting the fourth quarter.
- Operating expenses increased 23% to $209.4 million, including higher R&D, restructuring and impairment charges, amortization, share-based compensation, and productivity initiative costs. Operating earnings fell to $44.5 million from $83.7 million; higher interest expense also weighed on earnings.
- Backlog increased 32.9% to $308.1 million, primarily from additional China CT-tube orders. Backlog may be revised or canceled and is not assured revenue.
- Cash declined by $31.4 million while debt, net of issuance costs, declined by $94.1 million. Year-end gross debt was $398.0 million, including $25.0 million of current maturities.
Outlook, risks and unusual items
- The filing gives no formal FY2019 revenue or earnings guidance. Management expected China CT-tube shipments to increase in FY2019 and stated that long-term R&D spending of approximately 8%–10% of annual revenue is an appropriate range.
- The Santa Clara amorphous-silicon glass fabrication transfer to dpiX is expected to generate approximately $62.7 million of savings over five years. Varex recorded $14.2 million of restructuring and impairment charges for this initiative in FY2018 and expected another $4–$6 million of restructuring charges in FY2019. Total FY2018 restructuring charges disclosed were $16.7 million, including accelerated depreciation and other asset write-downs.
- Trade tensions and U.S./China tariffs had already adversely affected the business; management expected continued negative effects, including customer price concessions. Other significant risks include customer concentration (Canon accounted for 18.1% of FY2018 revenue), digital-detector price erosion, foreign exchange, volatile industrial/security orders, and reliance on sole- or limited-source suppliers, including dpiX.
- Debt bears floating rates; interest-rate swaps hedged $277.5 million of borrowings. Management estimated annual net earnings sensitivity of approximately $1.2 million for each one-percentage-point change in average borrowing rates, assuming borrowings remained constant.
- Tax reform produced a $2.6 million income-tax benefit and a negative 10.1% effective tax rate in FY2018. Certain tax amounts were provisional at filing. Environmental liability was approximately $1.3 million; the company reported no contingent liabilities at year-end and did not believe ordinary-course legal matters would result in material liability.
- Management and the auditor identified material weaknesses in internal controls over financial reporting, including IT access and change management, customer order/pricing, inventory, German operations, and the financial close process. Management said these had not caused a material misstatement of the statements, which received an unqualified audit opinion; the auditor issued an adverse opinion on internal-control effectiveness. Remediation was ongoing.
Important facts for investors to verify
- Whether China CT-tube orders convert to sales and whether the elevated backlog is retained and recognized.
- Progress, remaining costs, and realized savings from the detector-fabrication transfer and related restructuring.
- Whether gross margins recover despite product mix, detector price erosion, and tariff-related concessions.
- Debt repayment, covenant compliance, post-reduction revolver availability, and exposure to unhedged interest rates.
- Remediation and independent testing of the reported material weaknesses; monitor future filings for control-effectiveness conclusions.
- Finalization of provisional tax-reform accounting and any resulting changes to tax expense or deferred-tax balances.