Varex Imaging Corporation — Q1 FY2018 Form 10-Q
Reporting period: Three months ended December 29, 2017; comparison is with the three months ended December 30, 2016. Varex designs and sells X-ray imaging components and related software and services for medical and industrial markets. The company acquired PerkinElmer’s Medical Imaging business on May 1, 2017, so the prior-year comparison does not include that business; reported growth is not fully like-for-like.
Financial results and position
| Metric | Q1 FY2018 | Prior-year quarter | Change or context |
|---|---|---|---|
| Revenue | $176.2 million | $157.4 million | Up 11.9% |
| Gross profit / margin | $61.5 million / 34.9% | $58.8 million / 37.4% | Margin down 2.5 percentage points |
| Operating earnings | $13.6 million | $18.6 million | Down $5.0 million |
| Net earnings attributable to Varex | $11.3 million | $11.1 million | Nearly flat |
| Diluted EPS | $0.30 | $0.29 | |
| Operating cash flow | $40.1 million | $19.2 million | Higher, aided by receivables collections |
| Cash and cash equivalents | $94.1 million | $83.3 million at September 29, 2017 | |
| Total debt, net of issuance costs | $454.5 million | $483.9 million at September 29, 2017 | About $121 million of revolving facility availability remained |
Medical revenue was $139.2 million, up 5.7%; Industrial revenue was $37.0 million, up 44.0%. Gross profit was $46.4 million in Medical and $15.1 million in Industrial. Operating expenses rose 19.2% to $47.9 million, including R&D of $19.7 million versus $13.3 million. Interest and other expense, net, was $6.5 million versus $0.3 million, reflecting higher borrowing costs, equity-method investment losses and foreign-currency losses.
Net cash provided by investing activities was negative $2.6 million, primarily capital spending. Financing activities used $26.8 million, including $32.0 million of debt repayments. Cash increased by $10.8 million during the quarter. Current assets were $483.9 million and current liabilities were $148.8 million.
Material changes and management commentary
- Revenue growth reflected acquired detector-business sales and, in Medical, higher software and high-voltage cable sales. Medical gains were partly offset by lower dental and radiographic detector sales; Industrial growth was partly offset by lower cargo-screening system sales.
- Total gross margin declined mainly because of acquired-business intangible amortization, product mix toward lower-margin products and other indirect product costs. Medical gross margin was 33.3% versus 35.8%; Industrial was 40.8% versus 45.5%.
- Management said the company continues investing in innovation and considers R&D of approximately 8%–10% of annual revenue appropriate. The quarter’s R&D spending was 11.2% of revenue, driven by detector development and CT X-ray tube prototypes.
- Backlog was $193.3 million at December 29, down 22.2% from $248.4 million at September 29, 2017. Management attributed the decline primarily to customers placing quarterly rather than annual orders and cautioned that orders can be revised or canceled.
- Management believes operating cash flow, the credit facility and other liquidity sources will support operations, investment and strategic acquisitions, while noting future financing access depends on capital-market and economic conditions. No specific earnings or revenue guidance is provided.
Outlook, risks and unusual items
- The Tax Cuts and Jobs Act drove a reported $4.3 million income tax benefit and a negative 60.6% effective tax rate, compared with $7.1 million tax expense and a 38.8% rate a year earlier. The quarter included provisional estimates: $9.5 million benefit from revaluing deferred taxes and $3.4 million expense for deemed repatriation of foreign earnings. These estimates could change as the company completes its tax accounting.
- Future tax effects remain uncertain, including provisions concerning foreign earnings, GILTI, BEAT, FDII and interest-deduction limits. The company identified potential tax-liability and customer-demand effects as risks.
- Floating-rate borrowings expose the company to interest-rate changes. Six interest-rate swaps hedged $288.8 million of debt notional; total debt was $454.5 million. The company also cited foreign-exchange exposure, raw-material price volatility and concentration among suppliers.
- Toshiba Medical Systems represented 21.3% of quarterly revenue, down from 24.1% in the prior-year quarter, and 12.0% of receivables at quarter-end. A strong U.S. dollar, medical detector price erosion, customer discount requests or purchasing delays, and delayed industrial-security tenders were also identified as demand risks.
- The company reported no contingent liabilities at quarter-end and did not believe pending litigation would materially adversely affect operations or financial position. Product and customer indemnifications can have broad or potentially unlimited exposure, although no material related costs had been incurred. Disclosure controls were reported effective.
Investor verification checklist
- Separate organic growth from the acquired detector business’s contribution, particularly in Industrial revenue.
- Track gross-margin recovery and the effects of acquisition amortization, product mix and indirect costs.
- Assess whether the backlog decline reflects order timing or weaker underlying demand, and monitor conversion into revenue.
- Review debt, revolving-facility availability, floating-rate exposure and the effectiveness of interest-rate hedges.
- Follow finalization of provisional Tax Reform Act accounting and subsequent effective-tax-rate effects.
- Monitor Toshiba Medical Systems concentration, detector pricing pressure, customer order patterns and delayed security tenders.