Varex Imaging Corporation — Form 10-Q Summary
Business context and reporting period. This filing covers Varex’s third fiscal quarter ended June 30, 2017, and the nine months then ended. Varex designs, manufactures, sells, and services X-ray imaging components for medical, industrial, security, and inspection markets. It became independent of Varian on January 28, 2017; therefore, pre-separation results reflect allocated costs and may not be directly comparable with results as a standalone company.
Financial performance
Amounts are in millions of dollars, except per-share data. Quarter comparisons are against the three months ended July 1, 2016; nine-month comparisons are against the nine months ended July 1, 2016.
| Metric | Quarter ended June 30, 2017 | Prior-year quarter | Nine months ended June 30, 2017 | Prior-year nine months |
|---|---|---|---|---|
| Revenue | $170.1 | $151.4 | $482.4 | $448.0 |
| Gross margin | $59.5; 35.0% | $63.0; 41.6% | $175.8; 36.4% | $179.2; 40.0% |
| Operating earnings | $15.5 | $28.4 | $57.1 | $76.1 |
| Net earnings attributable to Varex | $10.6 | $17.6 | $36.8 | $46.5 |
| Diluted earnings per share | $0.28 | $0.47 | $0.97 | $1.23 |
| Operating cash flow | Not presented by quarter | $59.8 | $54.4 |
Quarterly revenue grew 12.4%; nine-month revenue grew 7.7%. The filing attributes much of the quarter’s growth to the acquired PerkinElmer Medical Imaging business (PKI Imaging), which contributed $26.7 million of revenue from May 1 through June 30. Quarterly operating and net earnings declined despite higher revenue, alongside lower gross margin and higher operating expenses. Approximate operating margin was 9.1% for the quarter versus 18.8% a year earlier, and 11.8% for the nine months versus 17.0%.
- Segments: Quarterly Medical revenue was $134.7 million versus $125.9 million, while Industrial revenue was $35.4 million versus $25.5 million. Nine-month Medical and Industrial revenue was $392.1 million and $90.3 million, respectively.
- Margins and expenses: Quarterly operating expenses rose 27.2% to $44.0 million. Management cited acquisition-related amortization and inventory step-up costs, digital-detector price erosion, product mix, and higher quality costs as pressures on gross margin. R&D spending increased, including development of CT tubes and detectors.
- Interest, tax, and other items: Quarterly interest expense was $4.2 million; nine-month interest expense was $5.8 million. Other income was $4.4 million for the quarter, primarily reflecting equity-method investment income and foreign-currency gains. Effective tax rates were 32.3% for the quarter and 34.6% for the nine months.
Balance sheet, cash flow, and financing
- At June 30, cash and cash equivalents were $89.3 million, current assets $506.3 million, and current liabilities $153.3 million. Inventory was $256.3 million, up from $197.4 million at September 30, 2016.
- Long-term debt was $478.7 million and current maturities were $20.0 million, both reported net of deferred issuance costs. The filing separately reports gross borrowings of approximately $510 million. Six interest-rate swaps covered $296.3 million of notional debt, leaving exposure to floating rates on the unhedged balance.
- Nine-month operating cash flow was $59.8 million. Investing cash use was $283.6 million, principally reflecting the PKI Imaging acquisition; financing cash provided was $275.9 million. Cash increased by $52.8 million over the period.
- The May 1 PKI Imaging acquisition was funded in part with a $400 million term facility and approximately $97 million drawn on a $200 million revolving facility. The credit agreement includes financial covenants and other restrictions.
Material changes, outlook, and risks
- Varex acquired PKI Imaging on May 1, 2017. Management expects the business to complement its detector operations and offer revenue and cost-synergy opportunities, but does not quantify expected synergies. The acquisition added $168.8 million of goodwill and $81.1 million of intangible assets; integration and purchase-accounting costs pressured current-period results.
- Backlog was $226.2 million at June 30, down 8.9% from September 30, 2016. Management attributed the decline mainly to customers placing quarterly rather than annual orders and cautioned that orders may be revised or canceled.
- Management said long-term R&D expense of approximately 8%–9% of annual revenue is appropriate. The filing provides no formal revenue or earnings guidance.
- Management highlighted pricing pressure and continued detector price erosion, customer order delays, a strong U.S. dollar, and delayed government tenders affecting security products. Toshiba Medical Systems represented 18.8% of quarterly revenue and 20.5% of nine-month revenue.
- Key risks include customer and OEM concentration, competition and in-sourcing, acquisition integration and realization of benefits, debt service and covenant compliance, floating-rate exposure, reliance on limited or sole-source suppliers, regulatory and product-liability exposure, and international, currency, and government-budget uncertainty.
- The company reported no contingent liabilities at June 30, 2017 and said it had no currently pending litigation believed likely to materially adversely affect operations or financial position. Disclosure controls were deemed effective; no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- How much of reported growth and future performance depends on PKI Imaging, and whether expected integration benefits materialize.
- Whether gross-margin pressure from detector pricing, product mix, acquisition accounting, and quality costs persists or improves.
- Debt balances, required repayments, covenant headroom, and the portion of floating-rate exposure not covered by swaps.
- Backlog conversion and order trends, particularly given customer concentration and the shift to shorter ordering cycles.
- Cash availability: the filing says approximately $18.6 million was being held for transfers of assets and subsidiaries, and reports a $27.1 million transfer to Varian during the quarter.
- Acquisition consideration figures differ by disclosure: the notes report $273.3 million after working-capital adjustments, while MD&A cites $271.8 million net cash consideration. Investors should confirm the applicable purchase-price and cash-flow definitions.