Varex Imaging Corporation — Q2 FY2021 Form 10-Q
Reporting period: Quarter ended April 2, 2021; fiscal Q2 was 13 weeks. Six-month comparisons are not fully like-for-like: the current period was 26 weeks versus 27 weeks in the prior year. Financial statements are unaudited.
Business context and results
Varex designs, manufactures, sells and services X-ray imaging components and related software for medical and industrial markets. It reports Medical and Industrial segments. Q2 demand improved in several product areas as customers resumed purchases deferred during the pandemic, but management cautioned that recovery and demand remain uncertain.
| Metric | Q2 FY2021 | Q2 FY2020 | Six months FY2021 | Six months FY2020 |
|---|---|---|---|---|
| Revenue | $203.5 million | $197.0 million | $380.6 million | $397.1 million |
| Gross profit | $64.6 million | $57.6 million | $121.8 million | $118.7 million |
| Gross margin | 31.7% | 29.2% | 32.0% | 29.9% |
| Operating income | $15.8 million | $1.4 million | $21.9 million | $6.0 million |
| Interest and other expense, net | $12.6 million | $2.5 million | $23.4 million | $8.3 million |
| Net income (loss) attributable to Varex | $3.1 million | $(1.9) million | $(3.3) million | $(3.2) million |
| EPS, diluted | $0.08 | $(0.05) | $(0.09) | $(0.08) |
Financial position and cash flow
- Cash and cash equivalents: $111.1 million at April 2, 2021, versus $100.6 million at October 2, 2020. Cash plus restricted cash at period-end was $112.6 million.
- Debt: Net carrying value was $460.9 million, including $2.9 million of current maturities. The notes report approximately $512.3 million of total combined indebtedness before unamortized discounts and issuance costs. Principal included $200 million of 4.00% convertible notes due 2025 and $300 million of 7.875% secured notes due 2027.
- Liquidity: The $100 million asset-based revolving facility had no borrowings. Actual availability varies with the borrowing base. Management said cash, operating cash flow and ABL availability were expected to meet needs for at least the next 12 months.
- Six-month cash flow: Operating activities provided $19.9 million, investing activities used $8.4 million and financing activities used $1.0 million; cash and restricted cash increased $10.5 million. Capital expenditures were $7.8 million.
- Working capital indicators: Inventory was $248.2 million, down from $271.9 million at fiscal year-end; DSO was 58 days, down from 66.
Material changes versus prior periods
- Q2 revenue grew 3.3%; Medical revenue rose 0.8% and Industrial revenue rose 12.7%. Industrial growth chiefly reflected higher detector and connector sales for security and nondestructive inspection.
- Q2 gross margin rose 2.5 percentage points. Medical margin was 29.2% versus 27.8%; Industrial margin was 40.3% versus 34.6%. Management cited product mix, cost-reduction measures and improved cost management.
- Operating expenses fell 13.2% in Q2 to $48.8 million, with lower R&D and SG&A. Operating income increased to $15.8 million.
- For the six-month period, revenue declined 4.2%, principally from lower Medical sales; gross profit nonetheless increased 2.6% and gross margin improved 2.1 percentage points.
- Interest expense increased substantially following the 2020 convertible and senior secured note issuances. Higher losses from private-company investments also increased other expense.
- Operating cash flow declined to $19.9 million from $23.9 million, reflecting working-capital movements, including higher receivables and lower payables; inventory reductions provided cash.
Outlook, risks and unusual items
- Outlook: No specific revenue or earnings guidance is provided in the filing. Management said demand had continued to recover, but noted that purchases may reflect deferred end-user spending and could ease after backlog is satisfied. It expected pandemic-related logistics, supply-chain and manufacturing challenges to continue into 2022; raw-material shortages, freight costs and shipping delays were increasing.
- Backlog: $195.4 million at April 2, 2021, which the company expected to recognize over the next 12 months. Orders may be revised or cancelled, so conversion is uncertain.
- COVID-19 and operations: The pandemic had reduced demand in Industrial and certain higher-end Medical products and contributed to manufacturing and supply-chain uncertainty. The filing states future effects cannot be estimated reliably.
- Unusual items: Varex recorded a $3.5 million inventory write-down in Q2 for discontinued products. Restructuring charges were $0.3 million in Q2 and $0.6 million for six months. The company completed acquisition of the remaining 1.3% of Direct Conversion for approximately $1 million in April 2021.
- Concentration and commitments: Canon Medical Systems accounted for 17.8% of Q2 revenue and 14.6% of receivables at quarter-end. Varex estimated $8.7 million of remaining 2021 fixed-cost commitments under its dpiX agreement; it also had a further $1.2 million VEC investment commitment tied to milestones and expected to pay approximately $9.8 million for equipment and intellectual property during FY2021.
- Controls: Disclosure controls and internal control over financial reporting were not effective at quarter-end because previously identified material weaknesses remained. Remediation work was ongoing; management said additional operating time and testing were required before considering the weaknesses resolved.
- Other risks: Significant debt and restrictive covenants, customer and supplier concentration, tariffs and foreign-exchange exposure, product and regulatory risks, and potential dilution or cash obligations from convertible notes. The company reported no material contingent liabilities and no pending litigation known to have a material adverse effect.
Investor facts to verify
- Whether the demand recovery and $195.4 million backlog convert to revenue as expected, and whether orders are cancelled or deferred.
- Whether margins remain improved as product mix shifts and material, freight and supply-chain costs evolve.
- Cash generation, working-capital needs, borrowing-base availability and capacity to service the notes and comply with debt covenants.
- Progress and testing evidence for remediation of the material weaknesses in financial reporting controls.
- Exposure to Canon Medical Systems and key suppliers, particularly dpiX, and the impact of tariffs, raw-material constraints and foreign exchange.