Varex Imaging Corporation — Q1 FY2019 Form 10-Q
Reporting period: First fiscal quarter ended December 28, 2018; comparative quarter ended December 29, 2017. Varex designs and sells X-ray imaging components and related products and services through its Medical and Industrial segments. Financial amounts below are in millions of U.S. dollars, except per-share data.
Financial performance
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Revenue | $185.7 | $176.2 | +5.4% |
| Gross profit / gross margin | $60.0 / 32.3% | $61.5 / 34.9% | Profit down $1.5; margin down 2.6 points |
| Operating expenses | $49.6 | $47.9 | +3.5% |
| Operating earnings | $10.4 | $13.6 | Down $3.2 |
| Net earnings attributable to Varex | $3.0 | $11.3 | Down $8.3 |
| Diluted EPS | $0.08 | $0.30 | Down $0.22 |
| Operating cash flow | $20.0 | $40.1 | Down $20.1 |
- Medical revenue was $143.9, up 3.4%; Industrial revenue was $41.8, up 13.0%. Medical gross margin was 31.3% versus 33.3%; Industrial gross margin was 35.6% versus 40.8%.
- Management attributed Medical revenue growth mainly to detectors for oncology, dental and fluoroscopic applications, partly offset by lower CT tube and radiographic detector sales. Industrial growth was primarily from X-ray tubes and linear accelerators.
- Gross margin pressure reflected restructuring charges associated with discontinuing amorphous-silicon glass fabrication at the Santa Clara facility; Industrial margins also faced higher manufacturing costs. SG&A rose with restructuring and professional-service fees.
- Interest and other expense, net, was $6.3 versus $6.5. The 26.8% effective tax rate and $1.1 tax expense compare with a 60.6% tax benefit and $4.3 benefit in the prior-year quarter, which included one-time Tax Act benefits.
Cash, debt and liquidity
- Cash and cash equivalents were $55.1 at quarter-end, compared with $51.9 at September 28, 2018. Operating activities provided $20.0; investing used $3.4 and financing used $13.1. Cash-flow comparisons also reflect working-capital movements, including a $22.0 inventory cash use.
- Debt outstanding was $383.0 gross and $375.4 net of debt issuance costs, versus $398.0 gross and $389.8 net at fiscal year-end. The debt is under secured term and revolving facilities; approximately $137.0 of revolving capacity remained available.
- The company reduced its revolving commitment by $50.0 to $150.0 during the quarter. Credit facilities mature May 1, 2022, contain restrictive covenants and financial-ratio requirements, and borrowings are floating-rate. Interest-rate swaps covered $277.5 notional at quarter-end.
- Management stated that operating cash flow, credit availability and other liquidity sources should support operations, investment, strategic acquisitions and capital-structure management, while noting future financing access depends on market and economic conditions.
Material changes, outlook and risks
- Varex adopted ASC 606 using the modified retrospective method, reducing opening retained earnings by $4.1 net of tax. The reported-quarter revenue effect was not material; management did not expect a material FY2019 impact. The prior-year comparison remains under ASC 605.
- Remaining performance obligations were $300.0 at quarter-end, with a majority expected to be recognized over the next 12 months. This is not presented as a revenue or earnings forecast. No formal consolidated revenue or earnings guidance is provided in the filing. Management described long-term R&D spending of approximately 8%–10% of annual revenue as an appropriate range.
- Management said U.S.–China trade conflicts and tariffs had negatively affected the business, particularly detectors in China, and expected continued adverse effects. Other key exposures include customer concentration, price erosion in radiographic detectors, demand variability, foreign exchange, manufacturing costs, and reliance on limited or sole-source suppliers.
- Canon Medical Systems represented 18.3% of quarterly revenue and 15.4% of quarter-end receivables. The ten largest customers collectively represented approximately 52% of quarterly revenue.
- Disclosure controls were not effective at quarter-end because previously reported material weaknesses in IT general controls and business-process controls remained under remediation. Management said the weaknesses had not caused a material financial-statement misstatement, but remediation would require controls to operate effectively for a sufficient period and be tested.
- The company initiated patent-infringement litigation during the quarter and reported no currently pending litigation believed likely to materially adversely affect operations or financial position. It also disclosed a $14.7 fixed-cost commitment to dpiX for calendar 2019 and a 40% investment in dpiX, a key supplier, without control over its operations.
Important facts for investors to verify
- Whether restructuring-related costs and manufacturing pressures persist, and whether margins recover despite revenue growth.
- Whether tariffs, China demand, customer purchasing patterns and detector price competition continue to affect sales and profitability.
- Cash generation, inventory levels, debt repayment, covenant compliance and remaining borrowing availability.
- Progress in remediating the disclosed material weaknesses and the results of management’s control testing.
- Assumptions underlying the $300.0 remaining performance obligations and expected recognition timing, and any subsequent changes to outlook.
- Potential exposure from dpiX supplier commitments, customer concentration, the MeVis put rights and compensation obligations, and the patent litigation.