Business context and reporting period
Varex Imaging Corporation designs, manufactures and services X-ray imaging components and related software for medical and industrial applications. This unaudited Form 10-Q covers the fiscal third quarter ended June 29, 2018 (13 weeks) and the first nine months of fiscal 2018. Amounts below are in U.S. dollars; financial figures are in millions except per-share data.
Comparisons are affected by the May 2017 acquisition of PerkinElmer’s medical imaging business: the prior-year nine-month results include that business only from May 1, 2017. Thus, reported growth is not a like-for-like organic comparison.
Financial results and liquidity
| Metric | Q3 FY2018 | Q3 FY2017 | Nine months FY2018 | Nine months FY2017 |
|---|---|---|---|---|
| Revenue | $191.2 | $170.1 | $568.6 | $482.4 |
| Gross profit | $63.0 | $59.5 | $194.7 | $175.8 |
| Gross margin | 32.9% | 35.0% | 34.2% | 36.4% |
| Operating earnings | $7.3 | $15.5 | $38.1 | $57.1 |
| Net earnings attributable to Varex | $3.8 | $10.6 | $27.5 | $36.8 |
| Diluted EPS | $0.10 | $0.28 | $0.72 | $0.97 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $66.8 | $59.8 |
Q3 revenue rose 12.4%, but gross margin fell 2.1 percentage points and operating earnings declined about 53%. Nine-month revenue increased 17.9%, while operating earnings and Varex-attributable net earnings decreased. Management cited product mix, higher manufacturing costs and, for the nine-month comparison, higher acquired-intangible amortization as pressures on gross margin. Increased interest expense and foreign-currency translation losses also weighed on earnings.
Q3 segment revenue was $143.1 million for Medical, up 6.2%, and $48.1 million for Industrial, up 35.9%. Segment gross margins were 31.7% and 36.6%, respectively, compared with 33.6% and 40.1% a year earlier. Management attributed Medical growth to high-end radiographic digital detectors, X-ray tubes and high-voltage cables; Industrial growth reflected digital detectors and security and inspection products and services.
For the nine months, operating cash flow was $66.8 million, capital expenditures were $15.3 million, and cash declined $30.5 million to $52.8 million. Net cash from operations benefited from $32.5 million of accounts-receivable collections, partly offset by a $9.7 million inventory increase. Cash interest paid was $14.6 million. At June 29, debt was $408.0 million gross and $399.6 million net of issuance costs, down from $494.0 million gross at September 29, 2017. The company had $167 million available under its revolving facility. Current assets were $444.0 million and current liabilities $140.7 million.
Material changes, outlook and risks
- Detector production transfer: On July 31, 2018, Varex announced it would move amorphous-silicon glass fabrication from Santa Clara to the jointly owned dpiX facility in Colorado. The filing reports $6.1 million of Q3 transfer-related charges, including $3.0 million of intangible-asset impairment and $3.1 million of inventory and spare-part write-downs, plus approximately $1.0 million of other restructuring expenses. Varex expects an additional $13–$17 million of expenses from fiscal Q4 2018 through fiscal 2019, including accelerated depreciation and employee-related costs. Management estimates annual cost savings of $10–$13 million; these are expectations, not guaranteed results.
- Tax items: Q3 included a $1.3 million income-tax benefit; the nine-month benefit was $2.4 million. The effective rates were unusually negative, at (50.0)% and (9.4)%, respectively, reflecting the U.S. Tax Cuts and Jobs Act and other discrete items, including an approximately $2.1 million benefit from an accounting-method change. Certain tax estimates remained provisional.
- Debt and rates: Borrowings carry floating rates. Six interest-rate swaps covered $281.3 million of notional debt at quarter-end. Higher borrowing levels and rates increased interest expense.
- Commercial and operating risks: The filing notes medical-detector price erosion, product-mix and manufacturing-cost pressure, delayed security-product tenders in certain markets, foreign-exchange exposure and reliance on OEM customers. Canon accounted for 16.2% of Q3 revenue and 18.6% of nine-month revenue. Varex also relies on dpiX for supply and capacity; its remaining fixed-cost commitment for calendar 2018 was $8.2 million.
- Tariffs: Varex said tariffs had already adversely affected its business. After the quarter, China announced an intended 5% tariff on imported X-ray tubes; further tariffs or retaliation could raise costs or reduce customer demand.
- Contingencies and controls: The company reported no contingent liabilities at June 29, 2018 and said no pending litigation was believed likely to have a material adverse effect. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting.
The filing provides no specific revenue or earnings guidance. Management stated it believed operating cash flow and available credit would support operations and investment, while noting that future financing access depends on capital-market and economic conditions.
Important facts for investors to verify
- How much reported revenue growth reflects the acquired detector business versus underlying organic growth, and whether the acquisition is delivering expected returns.
- Whether gross-margin pressure from mix, price erosion and manufacturing costs persists, particularly as glass fabrication moves to dpiX.
- The timing, cash impact and realization of the expected $10–$13 million annual savings and $13–$17 million of additional transfer-related expenses.
- Debt paydown, borrowing costs, covenant headroom and exposure to floating interest rates, including the effectiveness of hedges.
- The effect of tariffs, foreign exchange, customer concentration and delayed industrial/security tenders on orders, margins and cash flow.
- Final tax accounting under the Tax Cuts and Jobs Act and any resulting change to the unusually low reported tax provision.