Varex Imaging Corporation — Q2 FY2017 Form 10-Q
Reporting period: Three and six months ended March 31, 2017; comparable periods ended April 1, 2016. Varex completed its separation from Varian on January 28, 2017. Pre-separation results include allocated Varian costs and may not represent results as a standalone company.
Financial performance
Quarter: Revenue increased 3.3% to $154.8 million. Gross profit was $57.6 million, down 2.5%, and gross margin fell to 37.2% from 39.5%. Operating earnings declined to $23.5 million from $25.2 million. Net earnings attributable to Varex were $15.0 million, versus $14.7 million; diluted EPS was $0.40, versus $0.39.
Medical revenue rose 2.8% to $125.7 million; Industrial revenue rose 5.8% to $29.1 million. Medical gross margin decreased to 35.5% from 38.1%; Industrial gross margin was 44.7%, versus 45.5%. Management attributed lower overall margin mainly to quality costs and a shift toward lower-margin radiographic components in a large tender order.
Six months: Revenue increased 5.3% to $312.2 million. Gross profit was essentially unchanged at $116.4 million, while gross margin declined to 37.3% from 39.2%. Operating earnings fell to $41.9 million from $47.7 million; net earnings attributable to Varex declined to $26.1 million from $28.9 million. Diluted EPS was $0.70, versus $0.77.
Cash flow and liquidity: Six-month operating cash flow was $33.0 million, compared with $26.9 million; capital expenditures were $6.7 million, versus $19.1 million. Cash increased to $79.6 million at March 31, 2017, from $36.5 million at September 30, 2016. Current assets were $424.5 million and current liabilities $145.8 million. Management said operating cash flow, credit facilities and other liquidity sources should support operations, investment and strategic acquisitions.
Debt: At March 31, reported borrowings totaled $202.3 million, including $15.0 million of current maturities. In connection with the subsequent acquisition, Varex replaced its previous facilities with a $400 million term facility and a $200 million revolving facility, drawing approximately $97 million on the revolver; proceeds funded the acquisition and repayment of the previous credit agreement. The filing gives pro forma combined indebtedness as “$[497] million,” so the precise stated figure should be verified.
Material changes and notable items
- On May 1, 2017, after quarter-end, Varex completed its acquisition of PerkinElmer’s Medical Imaging business for approximately $277.4 million in cash, including acquired cash, subject to post-closing adjustments. The acquired business had approximately 280 employees.
- Revenue growth was concentrated in APAC: six-month APAC revenue rose 25.2%, while Americas revenue fell 13.6%. Management cited lower Americas sales of X-ray sources, detectors and connectors, including a customer’s decision to insource a detector; APAC growth included tender-related shipments.
- Backlog was $219.8 million at March 31, down 11.5% from September 30, 2016, partly because some customers shifted to quarterly rather than annual orders. Management cautioned that orders may be revised or canceled.
- Toshiba Medical Systems represented 19.3% of quarterly revenue and 21.5% of six-month revenue, a material customer concentration.
- Varex expected to transfer approximately $45.1 million of excess cash and remaining transfer-related payments to Varian after quarter-end under the separation agreement.
Outlook, risks and contingencies
- Management expects long-term gross margins of 38%–40% and considers R&D spending of approximately 8%–9% of annual revenue appropriate. No specific revenue or earnings forecast was provided.
- Management cited continued detector price erosion, quality costs, product mix, manufacturing investment and customer pricing pressure as factors affecting margins. A strong U.S. dollar may prompt discounts, delayed purchases, insourcing or lower-cost alternatives; delayed tenders in oil-dependent economies and conflict zones weigh on security-product demand.
- The acquisition increases leverage and adds integration, employee-retention and customer-retention risks. The new secured credit facilities include financial and other restrictive covenants.
- Other prominent exposures include reliance on a limited number of OEM customers and suppliers, including dpiX; Toshiba concentration; foreign exchange and commodity-price changes; regulatory and product-quality obligations; and dependence on manufacturing facilities and timely customer orders.
- Varex reported no contingent liabilities at March 31, 2017 and said it had no currently pending litigation it believed could materially adversely affect operations or financial position. It had an estimated $8.1 million of dpiX fixed-cost commitments for the remainder of calendar 2017.
Most important facts for investors to verify
- Confirm the precise pro forma debt figure: the filing displays “$[497] million,” and assess debt service, covenant headroom and interest-rate exposure after the acquisition.
- Track acquisition integration, acquired-business performance, purchase-price adjustments and realized benefits against the new debt burden.
- Assess whether backlog converts to sales and whether APAC tender-driven growth offsets continued weakness in the Americas.
- Monitor gross-margin recovery toward management’s 38%–40% long-term range, including quality costs, detector pricing and product mix.
- Evaluate customer and supplier concentration, especially Toshiba and dpiX, and the effects of any further insourcing or order changes.
- Separate standalone operating costs from historical Varian allocations when comparing periods; also monitor the planned transfer of excess cash to Varian.