Varex Imaging Corporation — Q2 FY2018 Form 10-Q
Reporting period: Fiscal second quarter ended March 30, 2018; comparisons are with the quarter ended March 31, 2017. Six-month results cover the first half of fiscal 2018. Amounts are in U.S. dollars.
Business context and financial performance
Varex designs, manufactures, sells and services X-ray imaging components and software for medical and industrial markets. The company acquired PerkinElmer’s medical imaging business in May 2017, affecting year-over-year comparability.
| Metric | Q2 FY2018 | Q2 FY2017 | First half FY2018 | First half FY2017 |
|---|---|---|---|---|
| Revenue | $201.2 million | $154.8 million | $377.4 million | $312.2 million |
| Gross margin | $70.1 million; 34.8% | $57.6 million; 37.2% | $131.6 million; 34.9% | $116.4 million; 37.3% |
| Operating earnings | $17.2 million | $23.5 million | $30.7 million | $41.9 million |
| Net earnings attributable to Varex | $12.2 million | $15.0 million | $23.6 million | $26.1 million |
| Diluted EPS | $0.32 | $0.40 | $0.62 | $0.69 |
| Cash provided by operating activities | Not presented quarterly | Not presented quarterly | $45.5 million | $33.0 million |
| Capital expenditures | Not presented quarterly | Not presented quarterly | $6.9 million | $6.7 million |
Q2 revenue rose 30.0%; Medical revenue increased 26.1% to $158.5 million and Industrial revenue increased 46.7% to $42.7 million. For the first half, revenue rose 20.9%. First-half gross margin dollars grew 13.1%, while the gross margin percentage declined to 34.9%.
Balance sheet, debt and liquidity
- At March 30, 2018, cash and cash equivalents were $55.4 million, down from $83.3 million at September 29, 2017.
- Debt was $426.0 million gross and $417.1 million net of debt issuance costs, compared with $494.0 million gross and $483.9 million net at fiscal year-end. The company had $154 million available under its revolving facility.
- Current assets were $445.7 million and current liabilities were $137.0 million. First-half financing cash outflow was $66.7 million, principally reflecting $78.0 million in debt repayments.
- Six-month operating cash flow increased year over year; the company cited collections of receivables as a major contributor. Accounts receivable fell by $34.4 million in operating cash flow, and DSO improved to 58 days from 66 days at fiscal year-end.
Material changes and management commentary
- Despite revenue growth, Q2 operating earnings declined to $17.2 million from $23.5 million. Operating expenses rose 55.1% to $52.9 million, including higher R&D and SG&A costs. Management cited acquisition-related amortization, lower-margin product mix, other indirect product costs and higher Industrial manufacturing costs as factors reducing gross margin percentage.
- R&D spending increased to $22.0 million in Q2 and $41.8 million in the first half. Management stated that it considers R&D of approximately 8%–10% of annual revenue appropriate for long-term innovation.
- Q2 SG&A included $1.7 million of restructuring charges for a workforce reduction and consolidation of engineering activities. The company expected these charges to be completed in fiscal 2018 and 2019.
- The six-month tax benefit of $1.1 million contrasted with tax expense of $14.5 million in the prior-year period. Tax results reflected the Tax Cuts and Jobs Act, including a $9.5 million deferred-tax revaluation benefit and $3.4 million of deemed-repatriation tax expense. These estimates were provisional and subject to revision.
- Backlog was $187.9 million at March 30, down 24.4% from $248.4 million at September 29, 2017. Management attributed the decrease primarily to customers placing quarterly rather than annual orders and cautioned that orders may be revised or canceled.
- Management said operating cash flow, the credit facility and other liquidity sources should support operations, investment and strategic acquisitions. The filing provides no quantified revenue or earnings guidance.
Risks, contingencies and unusual items
- Canon (formerly Toshiba Medical Systems) represented 17.3% of Q2 revenue and 19.2% of first-half revenue, creating customer concentration exposure.
- Varex relies on dpiX for detector components and has a 2018 fixed-cost commitment of $16.3 million, of which $12.2 million remained at quarter-end. The company’s 40% investment in dpiX Holding generated $3.1 million of first-half equity-method income.
- Floating-rate borrowings expose the company to interest-rate changes; swaps hedged $285.0 million of debt notional at quarter-end. Foreign exchange, raw-material prices and a strong U.S. dollar may also affect results.
- The filing identifies potential tariff and trade-war impacts, including higher input costs or weaker demand. Medical radiographic detector price erosion and delayed security-product tenders were also cited as market pressures.
- The company reported no contingent liabilities at March 30, 2018 and said it did not believe pending litigation would materially adversely affect operations or financial position. Product indemnification obligations can be unlimited for certain claims, though management considered their estimated fair value minimal.
Most important facts for investors to verify
- How much reported revenue growth reflects the PerkinElmer acquisition versus organic demand, particularly in each segment.
- Whether gross-margin pressure from product mix, amortization and manufacturing costs persists, and whether operating expenses grow more slowly than revenue.
- Whether the lower backlog converts to revenue, given customer ordering patterns and cancellation risk.
- Debt repayment progress, interest expense and sensitivity to floating rates after hedging.
- Final tax accounting under the Tax Cuts and Jobs Act and any effect on future effective tax rates.
- Exposure to Canon, dpiX supply commitments, detector price erosion, foreign exchange and potential tariffs.