Varex Imaging Corporation — Q3 FY2020 Form 10-Q
Reporting period: 13 weeks ended July 3, 2020; nine-month year-to-date period ended the same date. Amounts are in U.S. dollars. Varex designs and sells X-ray imaging components and related products for medical and industrial markets.
Financial performance
| Metric | Q3 FY2020 | Q3 FY2019 | Nine months FY2020 | Nine months FY2019 |
|---|---|---|---|---|
| Revenue | $171.2 million | $196.7 million | $568.3 million | $578.2 million |
| Gross margin | $26.3 million; 15.4% | $60.7 million; 30.9% | $145.0 million; 25.5% | $185.1 million; 32.0% |
| Operating (loss) earnings | $(26.8) million | $4.6 million | $(20.8) million | $29.5 million |
| Net (loss) earnings attributable to Varex | $(28.3) million | $(1.4) million | $(31.5) million | $7.4 million |
| Diluted EPS | $(0.73) | $(0.04) | $(0.81) | $0.19 |
Q3 revenue declined 13.0% year over year. Medical revenue fell 9.2% to $137.6 million; Industrial revenue fell 25.5% to $33.6 million. Nine-month revenue was down 1.7%; Medical was up 0.9%, while Industrial declined 10.5%.
For the nine months, operating cash flow was $25.0 million, compared with $49.0 million a year earlier; capital expenditures were $19.5 million. Cash and cash equivalents were $87.4 million at July 3, versus $29.9 million at fiscal year-end. Working capital included $283.2 million of inventory, up from $248.2 million.
Gross debt was $474.5 million and reported net debt was $417.1 million, including a $52.4 million unamortized discount on the convertible notes. The company had $27.6 million of current debt maturities and $100 million of revolving-credit capacity available, subject to covenants. Total assets were $1.12 billion and total liabilities were $640.6 million.
Material changes and unusual items
- COVID-19-related demand weakness, delayed medical equipment installations, and lower industrial activity weighed on sales and product mix. Q3 gross margin fell to 15.4% from 30.9%.
- Varex recorded a $15.8 million inventory write-down for discontinued products and restructuring activity, included in cost of revenue. It also impaired $2.8 million of in-process research and development; no goodwill impairment was recorded, though management disclosed sensitivity to future assumptions.
- In June, Varex issued $200 million of 4.00% convertible senior notes due 2025. It also entered into convertible-note hedge and warrant transactions; the hedge cost $61.0 million, partly funded by $49.8 million of warrant proceeds. The initial conversion price was approximately $20.81 per share; warrants have a $24.975 strike price.
- Other expense included a $2.7 million write-off of an investment in a privately held company. Nine-month results also reflected higher warranty and slow-moving inventory reserves and additional reserves related to a German customs audit; the filing does not provide a clear amount for that audit reserve.
- Santa Clara facility closure and relocation restructuring charges were $4.0 million for the nine months. The company expected another $4.0–$8.0 million through December 2020. Separately, a July 29 workforce reduction affecting about 94 employees was expected to cost $2.5–$3.5 million in cash.
Outlook, liquidity and risks
The filing provides no formal revenue or earnings guidance. Management expected uncertainty in demand to continue at least through the remainder of calendar 2020, with continued pressure on industrial products and certain higher-end medical products. It cited declines in elective procedures and capital purchases, delayed installations, and reduced industrial and security demand; respiratory-diagnostic imaging demand partly offset those effects.
Going-concern warning: Varex was compliant with its credit covenants at July 3, 2020, but management said its current forecasts made violation of certain leverage covenants probable within the following 12 months, potentially as early as fiscal year-end 2020. An uncured default could accelerate credit-agreement borrowings and trigger cross-defaults on other debt and derivative obligations. The filing states these conditions raise substantial doubt about the company’s ability to continue as a going concern. Management was pursuing cost reductions, working-capital improvements, lower capital spending, and additional fundraising or credit-agreement changes, but gave no assurance of success.
Other material concerns include dependence on a concentrated OEM customer base (Canon represented 23.7% of Q3 revenue and 21.7% for the nine months), competitive pricing and product-mix pressure, tariffs and foreign-exchange exposure, and COVID-related supply-chain and manufacturing disruption. Disclosure controls were deemed ineffective, and previously identified material weaknesses in internal control over financial reporting remained unremediated as of July 3.
Key facts for investors to verify
- Whether Varex obtained covenant amendments, waivers, replacement financing, or other funding, and whether subsequent forecasts still indicate a risk of default.
- Whether revenue, orders, gross margins, and inventory levels recovered after the quarter, particularly in Industrial and higher-end Medical products.
- The cash and earnings effects of the inventory write-down, Santa Clara closure, workforce reduction, and other cost actions.
- Progress in remediating material weaknesses and restoring effective disclosure and financial-reporting controls.
- The cash, dilution, and conversion implications of the 2025 notes, including the effect of the related hedge and warrant transactions.