Varex Imaging Corporation — Q2 FY2020 Form 10-Q
Reporting period: 13 weeks ended April 3, 2020; six-month results are also compared with the six months ended March 29, 2019. Amounts are in millions except per-share data. Varex designs and sells X-ray imaging components and related products in Medical and Industrial markets.
Key financial results
| Metric | Q2 FY2020 | Q2 FY2019 | Six months FY2020 | Six months FY2019 |
|---|---|---|---|---|
| Revenue | $197.0 | $195.8 | $397.1 | $381.5 |
| Gross margin | $57.6; 29.2% | $64.4; 32.9% | $118.7; 29.9% | $124.4; 32.6% |
| Operating earnings | $1.4 | $14.5 | $6.0 | $24.9 |
| Net earnings (loss) attributable to Varex | $(1.9); $(0.05)/share | $5.8; $0.15/share | $(3.2); $(0.08)/share | $8.8; $0.23/share |
| Operating cash flow | Not presented separately for the quarter | $23.9 | $32.9 |
- Revenue mix: Q2 Medical revenue rose 4.4% to $155.4, while Industrial revenue fell 11.3% to $41.6. For the six months, Medical revenue increased 6.2% to $311.0 and Industrial declined 2.9% to $86.1.
- Margins and costs: Q2 gross margin percentage fell to 29.2% from 32.9%. Medical margin pressure reflected lower-margin product mix, higher material and freight costs, and detector price decreases; Industrial pressure reflected mix and material costs. Operating expenses increased 12.6% to $56.2, including higher R&D and SG&A.
- Cash and liquidity: Cash and equivalents were $24.2 at April 3, down from $29.9 at September 27, 2019. Current assets were $454.0 and current liabilities $198.1. Six-month operating cash flow was $23.9; investing cash use was $17.3 and financing cash use was $12.1. Inventory increased $34.2 during the six months.
- Debt: Debt outstanding was $383.0 net of deferred loan costs ($387.8 gross), versus $395.1 net at September 27. The company had $66 million of revolving capacity available at April 3 and drew an additional $65 million in April, after quarter-end, primarily to bolster liquidity. Credit facilities mature May 1, 2022; the company reported covenant compliance at April 3.
Material changes and unusual items
- Despite higher first-half revenue, gross margin, operating earnings, and net earnings declined year over year; the company reported a net loss in both Q2 and the first half.
- Management attributed Medical revenue growth mainly to CT X-ray tubes and dental detectors. Industrial weakness included lower sales of products for nondestructive inspection and cargo inspection.
- First-half Medical gross margin was affected by unfavorable mix, detector pricing, higher warranty and slow-moving inventory reserves, and additional reserves connected with a German customs audit.
- The Santa Clara facility closure and production relocation generated $2.5 of restructuring charges in the first half. Varex expected an additional $5.6–$9.6 of charges through December 2020, with operations at the facility expected to cease by the end of September 2020.
- Varex adopted lease accounting standard ASC 842 in FY2020. It disclosed a second-quarter correction to adoption-related lease balances, reducing the right-of-use asset by $2.3 and lease liabilities by $2.8, with a $0.3 increase to retained earnings; management concluded the error was not material and reported no material income-statement impact.
- Direct Conversion deferred acquisition consideration was settled in April 2020 through issuance of 0.3 million Varex shares.
Outlook, risks, and controls
- COVID-19: Management cited significant uncertainty in demand, supply chains, and manufacturing productivity, expected to continue at least through the remainder of FY2020. It warned that the impact on Q3 and later results could be more significant than in Q2. Delayed or canceled elective procedures and hospital capital purchases, reduced industrial demand, and disruption at the Philippines facility were identified risks.
- Liquidity actions: Varex temporarily reduced employee compensation and retirement matching and used furloughs and unpaid leave for certain U.S. employees. Management said it was evaluating further cash-preservation measures and sources of capital.
- No quantified financial guidance is provided in the supplied filing text. Management described long-term R&D spending of approximately 8%–10% of annual revenue as an appropriate range.
- Other key risks: Customer concentration (Canon represented 23.0% of quarterly revenue and 20.9% of first-half revenue), pricing and competitive pressure, tariffs and U.S.–China trade tensions, dependence on limited or sole-source suppliers, floating-rate debt, and potential covenant pressure if earnings weaken.
- Internal controls: Management concluded disclosure controls were not effective as of April 3 due to previously disclosed material weaknesses involving risk assessment/control environment and revenue, inventory, and financial-close processes. Remediation was ongoing and not yet considered complete.
- The filing states that no currently pending litigation was believed likely to have a material adverse effect. It also describes customary indemnification obligations with potentially uncapped exposure; no material costs had been incurred for these arrangements as of April 3.
Important facts for investors to verify
- How COVID-19 affected subsequent-quarter orders, production capacity, customer cancellations, and cash generation, especially given management’s warning of a more significant Q3 impact.
- Liquidity after the $65 million April borrowing, including remaining revolver availability, debt covenants, and the company’s ability to meet obligations if operating results weaken.
- Whether gross-margin pressure, detector price erosion, reserves, and customs-audit exposure persist or worsen.
- Progress in remediating material weaknesses and whether controls operate effectively over a sufficient testing period.
- Timing and total cost of the Santa Clara closure and related restructuring, plus inventory levels and the dpiX supplier commitment.