Business context and reporting period
Varex Imaging Corporation designs and manufactures X-ray tubes, digital detectors, linear accelerators, software and related components for medical imaging and industrial/security inspection. This Form 10-K covers fiscal 2020, a 53-week year ended October 2, 2020; fiscal 2019 was 52 weeks. The filing includes fourth-quarter results, but is principally an annual report.
Financial performance and liquidity
| Metric | FY2020 | FY2019 |
|---|---|---|
| Revenue | $738.3 million | $780.6 million |
| Gross profit / margin | $190.2 million / 26% | $256.7 million / 33% |
| Operating income (loss) | $(33.7) million | $45.7 million |
| Net income (loss) | $(57.4) million; attributable to Varex: $(57.9) million | $15.8 million; attributable to Varex: $15.5 million |
| Diluted EPS | $(1.49) | $0.40 |
| Cash from operating activities | $13.2 million | $71.9 million |
| Cash and cash equivalents at year-end | $100.6 million | $29.9 million |
| Working capital | $361.4 million | $263.3 million |
Revenue by segment was $584.5 million in Medical (down 2%) and $153.8 million in Industrial (down 16%). Medical gross margin fell to 23% from 32%; Industrial gross margin fell to 35% from 37%. Total operating expenses rose 6% to $223.9 million, including higher audit, consulting and patent-litigation costs.
Fourth-quarter revenue was $170.0 million versus $202.4 million in the prior-year quarter; gross profit was $45.2 million versus $71.6 million, and net loss was $26.2 million versus net income of $8.2 million.
Operating cash flow declined as the company reported a loss and inventory increased $42.7 million. Investing activities used $26.9 million, including facility construction and capital spending; financing activities provided $83.6 million. Gross debt was $511.3 million ($455.3 million net of unamortized discounts and issuance costs). It included $200 million of 4.00% convertible notes due 2025 and $300 million of 7.875% senior secured notes due 2027. The new $100 million asset-based revolving facility was undrawn at year-end, with availability subject to the borrowing base. Management said the refinancing and expected cash flows alleviated the prior substantial-doubt conclusion and supported liquidity for at least 12 months.
Material changes versus the prior comparable period
- Revenue fell 5%, while gross profit fell 26%; the company moved from operating and net profit to substantial losses.
- COVID-19 reduced demand for elective-procedure-related medical equipment, industrial inspection products and airport security products, and delayed customer installations. Increased demand for certain CT and radiographic systems partly offset the weakness. China demand recovered and full-year results there exceeded pre-pandemic expectations.
- Gross profit included $22.2 million of restructuring, product-discontinuation and purchase-accounting charges, compared with $9.4 million in FY2019. The company also recorded a $2.8 million intangible-asset impairment and wrote off a $2.7 million investment.
- Operating cash flow declined materially; year-end cash increased largely through financing. Backlog decreased 21.7% to $207.6 million.
- Debt was refinanced: the prior credit agreement was repaid and terminated, with proceeds from the new secured notes; the company also issued convertible notes and established the ABL facility.
Outlook, risks and unusual items
Management provided no specific numerical earnings or revenue guidance in the supplied filing text. It expected pandemic-related uncertainty into early calendar 2021 and said reduced industrial demand and weakness in certain higher-end medical products would continue to pressure near-term results. Management maintained that long-term demand drivers remained intact.
- COVID-19 and operations: Further outbreaks could weigh on demand, manufacturing capacity, supply chains and logistics. The Philippines facility operated at reduced capacity during the pandemic.
- Customer and market concentration: Canon represented 20.5% of FY2020 revenue; the five largest customers accounted for about 40%, and the ten largest about 52%. Many OEM customers also compete with Varex or have in-house manufacturing.
- Controls and reporting: Management and the auditor concluded internal control over financial reporting was ineffective at year-end due to material weaknesses involving the control environment, risk assessment, inventory/cost of revenue, and financial reporting close processes. Related adjustments were described as immaterial, but remediation was ongoing. The auditor’s opinion on the financial statements was unqualified; its opinion on internal controls was adverse.
- Debt and dilution: Debt service, restrictive covenants and ABL availability conditions create liquidity risks. Convertible-note conversion may require cash and/or shares; warrants could dilute shareholders if the stock price exceeds their strike price.
- Other exposures: Risks include tariffs and trade tensions, foreign exchange and raw-material costs, single-source suppliers, product liability and warranty claims, regulation, cybersecurity, litigation and potential indemnification liabilities connected with Varian. Management reported no pending litigation believed likely to materially affect operations or financial position. The filing describes a material expected cash-tax benefit from CARES Act NOL carrybacks.
- Asset valuation: COVID-related impairment testing found no goodwill impairment, but the $2.8 million in-process R&D asset was impaired. Goodwill fair values depend on judgmental forecasts and could be affected by weaker growth, margins or market multiples.
Important facts for investors to verify
- Whether demand, backlog and operating cash flow recover, particularly in Industrial and higher-end Medical products, and whether inventory levels normalize.
- Progress and independent validation of remediation for the material weaknesses in internal controls; review future filings for any further adjustments or restatements.
- Actual borrowing-base availability under the ABL, covenant headroom, cash generation and ability to meet the 2025 and 2027 debt maturities.
- The potential dilution and cash requirements from the convertible notes and related warrants, including applicable conversion and settlement terms.
- Customer concentration and exposure to Canon, tariffs, sole-source suppliers and international manufacturing disruptions.
- Reconcile the filing’s environmental-liability disclosures: it cites approximately $0.9 million related to CERCLA sites and approximately $2.0 million of environmental liability elsewhere.