Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis contains forward-looking statements relating to future events or our future financial or operating performance that involve risks and uncertainties, as set forth above under "Forward-Looking Statements." Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors described in this Annual Report on Form 10-K.
Our Business
Varex Imaging Corporation is a leading innovator, designer and manufacturer of X-ray tubes, digital detectors, linear accelerators and other image software processing solutions, which are critical components of a variety of X-ray based imaging equipment. Our success depends, among other things, on our ability to anticipate and respond to changes in our markets, the direction of technological innovation and the demands of our customers. For additional information on our business, see Part I, Item 1.
Impact of COVID-19, Inflation and the General Economic Environment
The unprecedented nature of the COVID-19 pandemic and its effect on the global economy began to significantly disrupt our business in fiscal year 2020 by initially reducing demand for our products followed by strong recovery in demand but increasing variability in supply of raw materials and manufacturing productivity.
During the twelve months ended September 30, 2022, demand for many of our products recovered to pre-pandemic levels and our business has continued to grow. We believe that demand for our products has increased due to increased investments in healthcare and diagnostics coupled with end-users (such as hospitals) making capital purchases that were previously deferred due to the uncertainty surrounding COVID-19. While we are encouraged by the recovery that we have seen, we remain cautious as many factors remain unpredictable and recent high rates of inflation have increased our costs and could negatively affect our future profit margins. The existence of inflation in the economy has resulted in, and may continue to result in, higher interest rates and capital costs, increased shipping costs, supply shortages, increased costs of labor, weakening exchange rates and other similar effects.
We continue to experience logistics, supply chain, and manufacturing challenges that we expect will continue into 2023. As economies around the world continue to recover, shortages in raw materials have become more widespread. During the latter half of fiscal year 2021 and throughout fiscal year 2022, we experienced shortages of certain materials and used more of our inventory on hand than we have used historically. Shortages of materials, particularly micro-controller chips and associated electronic components, have caused and may continue to cause, delays in manufacturing products for our customers. In some cases, raw material shortages and delivery delays from our suppliers are communicated to us with very little advanced warning, which has caused operational and customer order fulfillment challenges. While we are dedicating significant resources to manage, mitigate, and resolve these issues, we currently expect supply chain challenges to continue to impact our ability to deliver products to our customers over the next several quarters. Increased freight charges and shipping delays have also become more common and are expected to continue into the foreseeable future. Due to the rising cost environment, in addition to ongoing expense management, we began to raise prices on certain products in fiscal year 2022 and anticipate making further pricing adjustments throughout fiscal year 2023.
During the twelve months ended September 30, 2022, our manufacturing facilities continued to operate with minimal disruption. Notwithstanding the foregoing, local government lockdowns, particularly in China, have impacted, and could continue to impact, our manufacturing operations in affected countries.
The full extent to which the COVID-19 pandemic and ensuing supply chain challenges have and will directly or indirectly impact us, including our business, financial condition, and results of operations, will depend on future developments that are highly uncertain and cannot be accurately predicted. We will continue to actively monitor the situation and may take further actions that alter our business operations or that we determine are in the best interests of our employees, customers, suppliers, and stockholders. For additional information on risks related to the pandemic and other supply chain risks that could impact our results, see Part I, Item 1A - Risk Factors.
Fiscal Year
Our fiscal year is the 52- or 53-week period ending on the Friday nearest September 30. Fiscal year 2022 was the 52-week period that ended September 30, 2022, fiscal year 2021 was the 52-week period that ended October 1, 2021, and fiscal year 2020 was the 53-week period that ended October 2, 2020. Set forth below is a discussion of our results of operations for fiscal years 2022, 2021 and 2020.
Results of Operations
Our annual report on Form 10-K for the fiscal year ended October 1, 2021, filed November 19, 2021, includes a discussion and analysis of our year-over-year changes, financial condition, and results of operations for the fiscal years ended October 1, 2021
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and October 2, 2020 in Item 7 of Part II therein. Our year-over-year changes, financial condition, and results of operations for the fiscal years ended September 30, 2022 and October 1, 2021 are set forth below.
Comparison of Results of Operations for Fiscal Year 2022 and 2021
Revenues, net
Medical as a percentage of total revenues 78.5 % 78.7 % 79.2 %
Industrial as a percentage of total revenues 21.5 % 21.3 % 20.8 %
Medical revenues increased $30.9 million in fiscal year 2022 compared to 2021 primarily due to increased sales of X-ray tubes and digital detectors for CT, oncology and dental applications in fiscal year 2022.
Industrial revenues increased $10.4 million due to increased sales of X-ray tubes for airport security and digital detectors for inspection applications in fiscal year 2022.
Revenues by Region
Americas as a percentage of total revenues 31.8 % 32.8 % 34.5 %
EMEA as a percentage of total revenues 32.7 % 33.8 % 31.4 %
APAC as a percentage of total revenues 35.5 % 33.4 % 34.1 %
The Americas revenues increased $4.8 million in fiscal year 2022 compared to 2021 primarily due to increased sales of digital detectors, high voltage cables, and computer-aided detection software in fiscal year 2022. EMEA revenues increased $4.5 million primarily due to increased sales of X-ray tubes and security inspection systems and machines. APAC revenues increased $32.0 million primarily due to increased sales of OEM X-ray tubes and digital detectors in China.
Gross Profit
Gross profit increased $12.0 million in fiscal year 2022 compared to 2021. The Medical segment gross profit in 2022 increased $7.3 million primarily due to the increased sales of CT X-ray tubes and oncology modalities partially offset by higher freight and material costs. The Industrial segment gross profit in 2022 increased $4.7 million primarily as a result of increased sales of digital detectors for dynamic imaging applications and non-destructive inspection applications, partially offset by higher freight and material costs.
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Operating Expenses
As a percentage of total revenues 9.0 % 8.8 % 10.7 %
As a percentage of total revenues 13.8 % 15.3 % 19.3 %
Impairment of intangible assets $ — —% $ — (100)% $ 2.8
As a percentage of total revenues — % — % 0.4 %
As a percentage of total revenues 22.7 % 24.1 % 30.3 %
Research and Development
Research and development costs for fiscal year 2022 increased to 9.0% of revenues primarily due to increased spending on material costs supporting research and development initiatives and includes $1 million in costs related to a development agreement entered into during the fourth quarter of fiscal year 2022 with a third-party company. See Note 12, Commitments and Contingencies, included in the accompanying Notes to Consolidated Financial Statements. We are committed to investing in research and development efforts to support long-term growth objectives by bringing new and innovative products to market for our customers.
Selling, General and Administrative
Selling, general and administrative expenses as a percentage of total revenues decreased to 13.8% for fiscal year 2022 from 15.3% for fiscal year 2021 due to lower compensation costs and higher revenue.
Interest and Other Expense, Net
The following table summarizes our interest and other expense, net:
Interest and other expenses, net $ (43.7) (4)% $ (45.5) 17% $ (38.9)
Interest and other expense, net decreased in fiscal year 2022 compared to fiscal year 2021. Interest income increased primarily due to an increase in investments made into marketable debt securities. Interest expense decreased due to the redemption of $27 million of our Senior Secured Notes in March 2022 and the redemption of $30 million of our Senior Secured Notes in July 2021, as well as reduced fees on the ABL Facility.
Taxes on Income
Fiscal Years
Effective tax rate 30.8 % 37.4 %
We had an income tax expense of $13.7 million and an income tax expense of $10.7 million, for effective rates of 30.8% and 37.4%, for fiscal years 2022 and 2021, respectively.
During fiscal year 2022, our effective tax rate varied from the U.S. federal statutory rate of 21% primarily due to the unfavorable impact of profit in foreign jurisdictions with statutory tax rates greater than 21% and also U.S. deferred tax attributes and losses in certain foreign jurisdictions for which a valuation allowance is provided. These unfavorable items were partially offset by the favorable impact of U.S. tax reform regarding international provisions, return to provision adjustments, and R&D tax credits.
During fiscal year 2021, our effective tax rate varied from the U.S. federal statutory rate of 21% primarily due to the unfavorable impact of U.S. deferred tax attributes and losses in certain foreign jurisdictions for which no benefit was recognized and a reduction in benefit for U.S. net operating losses carried back to prior years. These unfavorable items were partially offset by the favorable impact of R&D tax credits and U.S. tax reform regarding international provisions.
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We estimated the fiscal year 2022 GILTI (global intangible low-taxed income), BEAT (base-erosion anti-abuse tax), FDII (foreign-derived intangible income), limitations on interest expense deductions, and other components of U.S. tax reform, and have included these amounts in the calculation of the fiscal year 2022 tax provision. We made an accounting policy election, as allowed by the SEC and FASB, to recognize the impact of GILTI as a period cost if and when incurred.
Liquidity and Capital Resources
We assess our liquidity in terms of our ability to generate cash to fund our operations, including working capital and investing activities. We continue to generate cash from operating activities and believe that our operating cash flow, cash on our balance sheet and availability under our ABL facility are sufficient to meet our anticipated operating cash needs for at least the next 12 months and will be sufficient to allow us to continue to invest in our existing businesses, consummate strategic acquisitions and manage our capital structure on a short and long-term basis. We are currently not aware of any trends or demands, commitments, events, or uncertainties that will result in or that are reasonably likely to result in our liquidity increasing or decreasing in any material way that will impact our capital needs during or beyond the next 12 months. See Item 1A. “Risk Factors” for a further discussion. The maximum availability under our ABL Facility was $100.0 million as of September 30, 2022; however, the borrowing base under the ABL Facility fluctuates from month-to-month depending primarily on the amount of eligible accounts receivable and inventory. As of September 30, 2022 the amount available under our ABL Facility was $94.5 million, and the ABL Facility remained undrawn. At September 30, 2022 we had $412.3 million in long-term debt, net of discounts and deferred issuance costs of $35.3 million.
On March 18, 2022, the Company redeemed $27 million of principal of our $270.0 million, 7.875% Senior Secured Notes due 2027 (the "Senior Secured Notes"), in accordance with the terms and conditions of the governing indenture by paying cash of $28.7 million, inclusive of the redemption premium and accrued interest, and recognized a $1.2 million loss related to the redemption premium and the write-off of previously recorded debt issuance costs. See Note 9, Borrowings, in the accompanying Notes to Consolidated Financial Statements for more information regarding our indebtedness.
Our consolidated cash and cash equivalents decreased from $144.6 million as of October 1, 2021, to $89.4 as of September 30, 2022. This decrease was primarily due to capital expenditures of $21.3 million, debt repayments of $29.4 million, and net purchases of marketable debt securities of $16.7 million and certificates of deposit of $7.2 million, offset by cash inflows from operating activities of $16.9 million and $4.9 million in proceeds from shares issued under employee stock purchase plan.
Cash and Cash Equivalents, Certificates of Deposit, and Marketable Debt Securities
The following table summarizes our cash and cash equivalents, certificates of deposit, and marketable debt securities:
(In millions) September 30, 2022 October 1, 2021 $ Change % Change
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Borrowings
The following table summarizes the changes in our debt outstanding:
Current maturities of long-term debt
Current portion of other debt $ 2.1 $ 2.8 $ (0.7) (25.0) %
Total current maturities of long-term debt: $ 2.1 $ 2.8 $ (0.7) (25.0) %
Non-current maturities of long-term debt:
Convertible Senior Unsecured Notes $ 200.0 $ 200.0 $ — — %
Total non-current maturities of long-term debt: $ 447.6 $ 477.8 $ (30.2) (6.3) %
Unamortized issuance costs and debt discounts
Unamortized discount - Convertible Notes $ (28.7) $ (37.6) $ 8.9 (23.7) %
Unamortized issuance costs - Convertible Notes (3.1) (4.1) 1.0 (24.4) %
Debt issuance costs - Senior Secured Notes (3.5) (4.4) 0.9 (20.5) %
Cash Flows
Fiscal Years
Net cash flow provided by (used in):
Effects of exchange rate changes on cash and cash equivalents (0.2) (0.1) 0.9
Net (decrease) increase in cash and cash equivalents $ (55.5) $ 44.0 $ 70.8
Net cash provided by operating activities. Net cash provided by operating activities was $16.9 million and $92.6 million for the fiscal years 2022 and 2021, respectively. The decrease in cash provided by operating activities was primarily due to increased purchases of inventory during fiscal year 2022.
Net cash used in investing activities.Cash used in investing activities was $48.4 million and $16.2 million for the fiscal years 2022 and 2021, respectively. The increase in cash used in investing activities was primarily due to the purchase of investments and higher capital spending during the twelve months ended September 30, 2022.
Net cash (used in) provided by financing activities. Net cash used in financing activity for the twelve months ended September 30, 2022, was $23.8 million and was primarily due to our early redemption of $27 million of our Senior Secured Notes. Net cash used in financing activities for the twelve months ended October 1, 2021, was $32.3 million and was primarily due to our early redemption of $30 million of our Senior Secured Notes.
Days Sales Outstanding
Trade accounts receivable days sales outstanding (“DSO”) was 68 days and 62 days at September 30, 2022 and October 1, 2021, respectively. Our accounts receivable and DSO are impacted by a number of factors, primarily including the timing of product shipments, collections performance, payment terms, the mix of revenues from different regions and the effects of economic instability.
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Contractual Obligations
The following table summarizes, as of September 30, 2022, the total amount of future payments due in various future periods:
Payments Due by Period
dpiX fixed cost commitment 3.3 3.3 — — —
Dividends to MeVis noncontrolling interest 3.1 0.4 0.9 0.9 0.9
Supplier equipment acquisition 2.5 2.5 — — —
Development and share purchase commitments 6.6 6.6 — — —
We lease office space under non-cancelable operating leases. For further information on our operating leases, see Note 3,Leases, included in the accompanying Notes to Consolidated Financial Statements.
For further discussion regarding our borrowings, see Note 9, Borrowings, included in the accompanying Notes to Consolidated Financial Statements.
In October 2013, we entered into an amended agreement with dpiX and other parties that, among other things, provides us with the right to 50% of dpiX’s total manufacturing capacity produced after January 1, 2014. The amended agreement requires us to pay for 50% of the fixed costs (as defined in the amended agreement), as determined at the beginning of each calendar year. For the remainder of calendar year 2022, we estimate that we have fixed cost commitments of $3.3 million related to this amended agreement. The fixed cost commitment for future periods will be determined and approved by the dpiX board of directors at the beginning of each calendar year. The amended agreement will continue unless the ownership structure of dpiX changes (as defined in the amended agreement).
In October 2015, pursuant to a Domination and Profit and Loss Transfer Agreement (the “MeVis Agreement”), we committed to grant the noncontrolling shareholders of MeVis: (1) an annual recurring net compensation of €0.95 per MeVis share; and, (2) a put right for their MeVis shares at €19.77 per MeVis share. The annual net payment will continue for the life of the MeVis Agreement, which we anticipate will continue for as long as we remain as the controlling shareholder of MeVis. As of September 30, 2022, noncontrolling shareholders together held approximately 0.5 million shares of MeVis, representing 26.3% of the outstanding shares.
Varex entered into a purchase agreement with a supplier to acquire certain equipment and intellectual property from the supplier that is utilized to manufacture X-ray cables utilized in Varex's products. For more information about our supplier equipment acquisition, see Note 12, Commitments and Contingencies, included in the accompanying Notes to Consolidated Financial Statements.
In the fourth quarter of fiscal year 2022, the Company entered into a development agreement and a share purchase agreement with a third-party company. For more information about these agreements, see Note 12, Commitments and Contingencies, included in the accompanying Notes to Consolidated Financial Statements.
Contingencies
From time to time, we are a party to or otherwise involved in legal proceedings, government inspections, investigations, customs and duty audits, and other claims and contingency matters, both inside and outside the United States, arising in the ordinary course of its business or otherwise. We accrue amounts for probable losses, to the extent they can be reasonably estimated, that we believe are adequate to address any liabilities related to legal proceedings as well as other loss contingencies that we believe will result in a probable loss (including, among other things, probable settlement value). A loss or a range of loss is disclosed when it is reasonably possible that a material loss will be incurred and can be estimated or when it is reasonably possible that the amount of a loss, when material, will exceed the recorded provision. We did not have any material contingent liabilities as of September 30, 2022 and October 1, 2021. Legal expenses are expensed as incurred.
See Part 1, Item 3 of this Annual Report for additional information regarding legal proceedings and Note 12, Commitments and Contingencies, in the Notes to Consolidated Financial Statements for further information regarding certain of our contractual obligations and contingencies, which discussion is incorporated herein by reference.
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Critical Accounting Policies and Estimates
The preparation of our consolidated financial statements and related disclosures in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates and assumptions are based on historical experience and on various other factors that we believe are reasonable under the circumstances. Our critical accounting policies that are affected by accounting estimates require us to use judgments, often as a result of the need to make estimates and assumptions regarding matters that are inherently uncertain, and actual results could differ materially from these estimates.
We periodically review our accounting policies, estimates and assumptions and make adjustments when facts and circumstances dictate. Such accounting policies require us to use judgments, often as a result of the need to make estimates and assumptions regarding matters that are inherently uncertain, and actual results could differ materially from these estimates. Our critical accounting policies that are affected by accounting estimates include valuation of inventories, assessment of recoverability of goodwill and intangible assets, and income taxes. Note 1, Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements, Item 8 of this Form 10-K describes the significant accounting policies and methods used in the preparation of the Company’s consolidated financial statements. Such accounting policies require us to use judgments, often as a result of the need to make estimates and assumptions regarding matters that are inherently uncertain, and actual results could differ materially from these estimates. For a discussion of how these estimates and other factors may affect our business, see Item 1A. “Risk Factors.”
Inventories, net
Inventory is valued at the lower of cost or net realizable value. Costs include materials, labor, external service and manufacturing overhead and is computed using standard cost (which approximates actual cost) on a first-in-first-out basis. We evaluate the carrying value of our inventories taking into consideration such factors as historical and anticipated future sales compared to quantities on hand and the prices we expect to obtain for products in our various markets. We adjust excess and obsolete inventories to net realizable value, and write-downs of excess and obsolete inventories are recorded as a component of cost of revenues.
Goodwill and Intangible Assets
Goodwill is initially recorded when the purchase price paid for a business acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. Our future operating performance will be impacted by the future amortization of these acquired intangible assets and potential impairment charges related to these intangibles or to goodwill if indicators of impairment exist. The allocation of the purchase price from business acquisitions to goodwill and intangible assets could have a material impact on our future operating results. In addition, the allocation of the purchase price of the acquired businesses to goodwill and intangible assets requires us to make significant estimates and assumptions, including estimates of future cash flows expected to be generated by the acquired assets and the appropriate discount rate for those cash flows. Should conditions differ from management’s estimates at the time of the acquisition, material write-downs of intangible assets and/or goodwill may be required, which would adversely affect our operating results.
We evaluate goodwill for impairment at least annually or whenever an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The evaluation includes consideration of qualitative factors including industry and market considerations, overall financial performance, and other relevant events and factors affecting the reporting unit. If we determine that a quantitative analysis is necessary, we perform a quantitative analysis that consists of a comparison of the fair value of a reporting unit against its carrying amount, including the goodwill allocated to each reporting unit. We determine the fair value of our reporting units based on a combination of income and market approaches. The income approach is based on the present value of estimated future cash flows of the reporting units and the market approach is based on a market multiple calculated for each reporting unit based on market data of other companies engaged in similar business. If the carrying amount of the reporting unit is in excess of its fair value, the difference between the fair value and carrying amount is recorded as an impairment loss. The impairment test for intangible assets with indefinite useful lives, if any, consists of a comparison of fair value to carrying value, with any excess of carrying value over fair value being recorded as an impairment loss.
In fiscal years 2022, 2021 and 2020, we performed the annual goodwill impairment test for our two reporting units and found no impairment. We performed the annual goodwill analysis as of the first day of the fourth quarter of each fiscal year (using balances as of the end of the third quarter of that fiscal year). For both reporting units, based upon the annual goodwill analysis that we performed as of the first day of the fourth quarter of the respective fiscal years, either a quantitative analysis of the impairment test was not completed based on evaluation of qualitative factors or, if quantitative analysis was completed, the fair value was substantially in excess of carrying value. However, significant changes in our projections of our operating results or other factors could cause us to make interim assessments of impairments in any quarter that could result in some or all of the goodwill being impaired.
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Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions, estimates, and market factors. Estimating the fair value of individual reporting units requires us to make assumptions and estimates regarding our future plans, as well as industry, economic, and regulatory conditions. These assumptions and estimates include estimated future annual net cash flows, income tax rates, discount rates, revenue growth rates, forecasted gross margins, market multiples, terminal value and other market factors. This fair value measurement was based on significant inputs not observable in the market and thus represents a Level 3 fair value measurement. If current expectations of future revenue growth rates and forecasted gross margins, both in size and timing, are not met, if market factors outside of our control, such as discount rates, change, if market multiples decline, or if management’s expectations or plans otherwise change, including as a result of the development of our global five-year operating plan, then one or more of our reporting units might become impaired in the future. The Company will continue to monitor the financial performance of and assumptions for its reporting units. A future impairment charge for goodwill could have a material effect on the Company's consolidated financial position and results of operations.
We will continue to make assessments of impairment on an annual basis or more frequently if indicators of potential impairment arise.
Taxes on Income
Current income tax expense or benefit is the amount of income taxes expected to be payable or receivable for the current year. Deferred income tax liabilities or assets are established for the expected future tax consequences resulting from the differences in financial reporting and tax bases of assets and liabilities. Future changes in tax regulation can have a material impact, including tax rate changes or the realization of deferred tax assets. A valuation allowance is provided if it is more likely than not that some or all of the deferred tax assets will not be realized. U.S. tax reform introduced a limitation of business interest deduction under IRC Section 163(j), which may be difficult to utilize without significant taxable income. Also, net operating loss carryforwards in jurisdictions with current losses provide uncertainty for realization. In addition, we provide reserves for uncertain tax positions when such tax positions do not meet the recognition thresholds or measurement standards prescribed by the authoritative guidance for accounting for income taxes. A portion of the U.S. general business tax credits for research outside of the financial statement line for research and development ("R&D") have a small degree of uncertainty. A reasonable reserve is maintained on the uncertain portion until either the Internal Revenue Service chooses to audit or the statute of limitation expires. A reserve for R&D is typical for companies who calculate and utilize this general business credit. Amounts for uncertain tax positions are adjusted in periods when new information becomes available or when positions are effectively settled. Interest and penalties related to uncertain tax positions are recognized as a component of income tax expense.
During fiscal year 2022, the Company received cash tax refunds related to net operating loss carryback claims for U.S. losses incurred in fiscal year 2020. On August 16, 2022, the Inflation Reduction Act was enacted in response to rising inflation. The Company does not meet financial statement thresholds for the minimum tax applicability and does not anticipate other provisions will have a material impact. The 2017 Tax Cuts and Jobs Act included a provision requiring research and development expenditures to be capitalized for tax years beginning after December 31, 2021, which is effective for the Company starting in fiscal year 2023. The Company has a significant amount of research and development expenditures and expects increased cash taxes in the early effective years related to this provision.
Recent Accounting Standards or Updates Not Yet Effective
See Note 1, Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements for a description of recent accounting standards, including the expected dates of adoption and the estimated effects on our consolidated financial statements.
Backlog
Backlog is the accumulation of all orders for which revenues have not been recognized and are still considered valid. Backlog also includes a small portion of billed service contracts that are included in deferred revenue. Our estimated total backlog at September 30, 2022 was approximately $425 million.
Orders may be revised or canceled, either according to their terms or as customers' needs change. Consequently, it is difficult to predict with certainty the amount of backlog that will result in revenues. We perform a quarterly review to verify that outstanding orders in the backlog remain valid. Aged orders that are not expected to be converted to revenues are deemed dormant and are reflected as a reduction in the backlog amounts in the period identified.
In addition to orders for which revenues have not been recognized and are still considered valid, we have pricing agreements with many of our established customers that span multi-year periods. These pricing agreements include volume ranges under which orders are placed.
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Item 7A. Quantitative and Qualitative Disclosures about Market Risks
We are exposed to four primary types of market risks: foreign currency exchange rate risk, credit and counterparty risk, interest rate risk and commodity price risk.
Foreign Currency Exchange Rate Risk
A significant portion of our customers are outside the United States, while our financial statements are denominated, and our products are generally priced in U.S. Dollars. A strong U.S. Dollar may result in pricing pressure for our customers that are located outside the United States and that conduct their businesses in currencies other than the U.S. Dollar. Such pricing pressure has caused, and could continue to cause, some of our customers to ask for discounted prices, delay purchasing decisions, or consider moving to in-sourcing supply of components or migrating to lower cost alternatives. In addition, because our business is global and some payments may be made in local currency, fluctuations in foreign currency exchange rates can impact our revenues and expenses and/or the profitability in U.S. Dollars of products and services that we provide in foreign markets.
We may enter into foreign currency forward and option contracts with financial institutions to protect against foreign exchange risks associated with certain existing assets and liabilities, net investments in foreign subsidiaries, and forecast purchases denominated in foreign currencies. We may hedge portions of forecasted foreign currency exposure, typically for one to three months. In addition, we hold a cross-currency swap between the Euro and U.S. Dollar as a net investment hedge of our acquisition of Direct Conversion. Depending on the spot rate between the Euro and U.S. Dollar at the time of settlement and whether we have sufficient Euros available, we may have to borrow incrementally in U.S. Dollars to settle this obligation. Additionally, we may choose not to hedge certain foreign exchange exposures for a variety of reasons including, but not limited to, accounting considerations, the prohibitive economic cost of hedging particular exposures, or due to natural offsets among the different exposures.
Credit and Counterparty Risk
We use a centralized approach to manage substantially all of our cash and to finance our operations. Our cash and cash equivalents and marketable securities may be exposed to a concentration of credit risk, and we may also be exposed to credit risk and interest rate risk to the extent that we enter into credit facilities.
We perform ongoing credit evaluations of our customers and we maintain what we believe to be strong credit controls in evaluating and granting customer credit, including performing ongoing evaluations of our customers’ financial condition and creditworthiness and often using letters of credit or requiring certain customers to provide a down payment.
Interest Rate Risk
Borrowings under our ABL Facility bear interest at floating interest rates. At September 30, 2022, we had no borrowings subject to floating interest rates. See Note 9, Borrowings, of the Notes to Consolidated Financial Statements for further information.
Our exposure to interest rate risk also is related to our interest-bearing assets, primarily our cash and cash equivalents and marketable securities. Fixed rate securities may have their market value adversely affected due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fluctuate due to changes in interest rates or we may suffer losses in principal if we are forced to sell securities that decline in market value due to changes in interest rates.
Commodity Price Risk
We are exposed to market risks related to volatility in the prices of raw materials used in our products. The prices of these raw materials fluctuate in response to changes in supply and demand fundamentals and our product margins and level of profitability tend to fluctuate with changes in these raw materials prices. We try to protect against such volatility through various business strategies. During the fiscal year ended September 30, 2022, we did not have any commodity derivative instruments in place to manage our exposure to price changes.
Item 8. Financial Statements and Supplementary Data.
The Consolidated Financial Statements and Schedules listed in the Index to Consolidated Financial Statements, Schedules and Exhibits on page F-1 are filed as part of this Annual Report and incorporated in this Item 8 by reference.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
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Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act") are designed to provide reasonable assurance that information required to be disclosed in our periodic reports that we file or submit under the Exchange Act are recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and that such information is accumulated and communicated to our management, including our principal executive and financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed, and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on this evaluation, the Chief Executive Officer (CEO) and Chief Financial Officer (CFO) have concluded that our disclosure controls and procedures were effective as of September 30, 2022.
Management's Annual Report on Internal Control Over Financial Reporting
Management, under the supervision of our CEO and CFO, is responsible for establishing and maintaining adequate internal control over our financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our management evaluated the design and operating effectiveness of our internal control over financial reporting based on the criteria established in the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the "COSO framework" (2013)). All internal control systems, no matter how well designed, have inherent limitations. Accordingly, even effective internal controls and procedures can provide only reasonable assurance with respect to financial statement preparation and presentation.
Under the supervision and with the participation of our management, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of September 30, 2022. Based on this evaluation, our management concluded that we maintained effective internal control over financial reporting as of September 30, 2022.
The effectiveness of our internal control over financial reporting as of September 30, 2022 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report, which appears below in “Item 9a. Controls and Procedures".
Changes in Internal Control Over Financial Reporting
There were no changes to our internal control over financial reporting during the quarter ended September 30, 2022, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and the Board of Directors of Varex Imaging Corporation
Opinion on Internal Control over Financial Reporting
We have audited the internal control over financial reporting of Varex Imaging Corporation and subsidiaries (the “Company”) as of September 30, 2022, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2022, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended September 30, 2022 of the Company and our report dated November 18, 2022, expressed an unqualified opinion on those financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Deloitte & Touche LLP
Salt Lake City, Utah
November 18, 2022
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Item 9B. Other Information
None.
Item 9C. Disclosures Regarding Foreign Jurisdictions that Prevent Inspections.
None.
PART III
Item 10. Directors, Executive Officers and Corporate Governance.
Directors and Executive Officers
The information required by this item with respect to our executive officers is set forth in Part I of this Annual Report on Form 10-K and information relating to the availability of our code of conduct for executive officers and directors is set out below. The other information required by this item is incorporated by reference from our definitive proxy statement for the 2023 Annual Meeting of Stockholders. Our definitive proxy statement for the 2023 Annual Meeting of Stockholders will be filed with the SEC no later than 120 days after September 30, 2022.
Code of Conduct
We have adopted a Code of Conduct that applies to all of our executive officers and directors. The Code of Conduct is available on our website at http://www.vareximaging.com.
We intend to comply with the disclosure requirements under Item 5.05(c) of Form 8-K regarding an amendment to, or waiver from, a provision of the Code of Conduct that applies to our principal executive officer, principal financial officer, principal accounting officer or persons performing similar functions by posting such information on our website, specified above.
Item 11. Executive Compensation
The information required by this item is incorporated by reference from our definitive proxy statement for the 2023 Annual Meeting of Stockholders under the caption “Executive Compensation.”
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Equity Compensation Plan Information
The following table provides information as of September 30, 2022 with respect to the shares of our common stock that may be issued under our existing equity compensation plans.
Equity compensation plans approved by security holders 3,947 $ 28.97 3,981
Equity compensation plans not approved by security holders — — —
(1) Consists of stock options, restricted stock units ("RSUs"), and deferred stock units ("DSUs") granted under the Varex Imaging Corporation 2017 Omnibus Stock Plan and the 2020 Stock Plan. Excludes purchase rights under the ESPP.
(2) The weighted average exercise price does not take into account the shares issuable upon vesting of outstanding RSUs and DSUs, which have no exercise price.
(3) Includes 3,157 thousand shares available for future issuance under the 2020 Stock Plan, and also includes 824 thousand shares available for future issuance under the ESPP. Shares available for issuance under the ESPP are subject to the number of shares remaining in the share reserve, and the maximum number of shares purchasable by any participant on any one purchase date for any purchase period, which may not exceed 2,000 shares.
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The information required by this item with respect to the security ownership of certain beneficial owners and the security ownership of directors and executive officers is incorporated by reference from our definitive proxy statement for the 2023 Annual Meeting of Stockholders under the caption “Stock Ownership—Beneficial Ownership of Certain Stockholders, Directors and Executive Officers.”
Item 13. Certain Relationships and Related Transactions and Director Independence.
The information required by this item with respect to certain relationships and related transactions is incorporated by reference from our definitive proxy statement for the 2023 Annual Meeting of Stockholders under the caption “Certain Relationships and Related Transactions.” The information required by this item with respect to director and committee member independence is incorporated by reference from our definitive proxy statement for the 2023 Annual Meeting of Stockholders under the caption “Proposal - Election of Directors.”
Item 14. Principal Accountant Fees and Services.
The information required by this item is incorporated by reference from our definitive proxy statement for the 2023 Annual Meeting of Stockholders under the caption “Proposal - Ratification of the Appointment of Our Independent Registered Public Accounting Firm.”
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PART IV
Item 15. Exhibits, Consolidated Financial Statements and Financial Statement Schedules.
Documents filed as part of this annual report include:
Exhibit Number Description
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21.1 List of Subsidiaries as of November 14, 2022
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101.SCH XBRL Taxonomy Extension Schema Document
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF XBRL Taxonomy Extension Definition Linkbase Document
101.LAB XBRL Taxonomy Extension Label Linkbase Document
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document
* Incorporated herein by reference
† Management contract or compensatory agreement.
Item 16. Form 10-K Summary
None
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
VAREX IMAGING CORPORATION
Date: November 18, 2022 By: /s/ Shubham Maheshwari
Shubham Maheshwari
Chief Financial Officer
(Duly Authorized Officer and Principal Financial Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Capacity Date
Sunny S. Sanyal
Shubham Maheshwari
/s/ RUEDIGER NAUMANN-ETIENNE Chairman of the Board November 18, 2022
Ruediger Naumann-Etienne
/s/ KATHLEEN L. BARDWELL Director November 18, 2022
Kathleen L. Bardwell
/s/ JOCELYN D. CHERTOFF Director November 18, 2022
Jocelyn D. Chertoff
/s/ TIMOTHY E. GUERTIN Director November 18, 2022
Timothy E. Guertin
/s/ JAY K. KUNKEL Director November 18, 2022
Jay K. Kunkel
/s/ WALTER M ROSEBROUGH, JR. Director November 18, 2022
Walter M Rosebrough, Jr.
/s/ CHRISTINE A. TSINGOS Director November 18, 2022
Christine A. Tsingos
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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm (PCAOB ID No. 34) F-1
Report of Independent Registered Public Accounting Firm (PCAOB ID No. 238) F-3
Consolidated Balance Sheets as of the end of fiscal years 2022 and 2021 F-6
Notes to Consolidated Financial Statements F-9
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and the Board of Directors of Varex Imaging Corporation
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Varex Imaging Corporation and subsidiaries (the "Company") as of September 30, 2022 and October 1, 2021, the related consolidated statements of operations, comprehensive income (loss), stockholders' equity, and cash flows for each of the two years in the period ended September 30, 2022, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2022 and October 1, 2021, and the results of its operations and its cash flows for each of the two years in the period ended September 30, 2022, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of September 30, 2022, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated November 18, 2022, expressed an unqualified opinion on the Company's internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Inventories – Valuation of Excess and Obsolete Inventories — Refer to Note 1 to the financial statements
Critical Audit Matter Description
Inventories are valued at the lower of cost or net realizable value. The Company evaluates the carrying value of its inventories taking into consideration such factors as historical sales and anticipated future sales compared to quantities on hand and the prices the Company expects to obtain for products in its various markets. The Company adjusts excess and obsolete inventories to net realizable value, and write-downs of excess and obsolete inventories are recorded as a component of cost of revenues. As of September 30, 2022, the Company’s inventories, net, were $303.2 million. For the year ended September 30, 2022, inventory write-downs were $6.4 million. Estimating the amount of excess and obsolete inventories involves significant judgment and estimates.
We identified the valuation of excess and obsolete inventories as a critical audit matter because of management’s significant judgment and estimates in determining the valuation of excess and obsolete inventories primarily around anticipated future sales. This required a high degree of auditor judgment and an increased extent of effort.
How the Critical Audit Matter Was Addressed in the Audit
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Our audit procedures related to management’s estimates of the valuation of excess and obsolete inventories included the following, among others:
•We tested the effectiveness of controls over the valuation of excess and obsolete inventories. The controls we tested included those over the calculation, and accuracy and completeness of underlying data used in the calculation, including historical sales and anticipated future sales by product, product quantities on hand, and applicable prices.
•We evaluated management’s ability to accurately estimate the valuation of excess and obsolete inventories by comparing actual inventory write-downs to management’s historical estimates.
•We performed procedures to evaluate the reasonableness of management’s methods, assumptions, and judgments used in developing their estimate of the valuation of excess and obsolete inventories, which included consideration of historical sales, anticipated future sales, and information obtained from production planning and supply chain employees.
•We tested the accuracy and completeness of the underlying data used in the Company’s calculations of the valuation of excess and obsolete inventories, including historical usage, anticipated future sales, quantities on hand, and pricing
•We assessed the reasonableness of the assumptions used in the calculations of the valuation of excess and obsolete inventories by developing an independent expectation and comparing our independent expectation to the results of the Company’s calculations.
•We tested the mathematical accuracy of the Company’s calculations of excess and obsolete inventories.
/s/ Deloitte & Touche LLP
Salt Lake City, Utah
November 18, 2022
We have served as the Company’s auditor since 2021.
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Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of Varex Imaging Corporation
Opinion on the Financial Statements
We have audited the consolidated statements of operations, of comprehensive income (loss), of stockholders’ equity and of cash flows of Varex Imaging Corporation and its subsidiaries (the "Company") for the year ended October 2, 2020, including the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the results of operations and cash flows of the Company for the year ended October 2, 2020 in conformity with accounting principles generally accepted in the United States of America.
Change in Accounting Principle
As discussed in Note 3 to the consolidated financial statements, the Company changed the manner in which it accounts for leases as of September 28, 2019.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit of these consolidated financial statements in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.
Our audit included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Salt Lake City, Utah
November 30, 2020
We served as the Company's auditor from 2016 to 2020.
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VAREX IMAGING CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
Fiscal Years
Operating expenses:
Impairment of intangible assets — — 2.8
Other expense, net (4.3) (3.5) (7.6)
Interest and other expense, net (43.7) (45.5) (38.9)
Less: Net income attributable to noncontrolling interests 0.5 0.5 0.5
Net income (loss) attributable to Varex $ 30.3 $ 17.4 $ (57.9)
Net income (loss) per common share attributable to Varex
Weighted average common shares outstanding
See accompanying Notes to Consolidated Financial Statements.
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VAREX IMAGING CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Fiscal Years
Other comprehensive income (loss), net of tax
Unrealized income on interest rate swap contracts — — 0.4
Unrealized gain (loss) on defined benefit obligations 1.4 (0.1) 0.6
Unrealized loss on forward contracts (0.6) — —
Unrealized loss on available-for-sale securities (0.1) — —
Foreign currency translation adjustments (0.6) (0.7) 1.5
Total comprehensive income (loss) 30.9 17.1 (54.9)
Less: Comprehensive income attributable to noncontrolling interests 0.5 0.5 0.5
Comprehensive income (loss) attributable to Varex $ 30.4 $ 16.6 $ (55.4)
See accompanying Notes to Consolidated Financial Statements.
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VAREX IMAGING CORPORATION
CONSOLIDATED BALANCE SHEETS
(In millions, except share amounts) September 30, 2022 October 1, 2021
Assets
Current assets:
Cash and cash equivalents $ 89.4 $ 144.6
Prepaid expenses and other current assets 44.0 29.5
Property, plant and equipment, net 141.3 140.2
Intangible assets, net 33.6 50.7
Investments in privately-held companies 46.4 49.3
Deferred tax assets 2.3 4.0
Operating lease assets 23.2 24.3
Liabilities and stockholders' equity
Current liabilities:
Accrued liabilities and other current liabilities 81.4 89.7
Current operating lease liabilities 4.0 6.2
Current maturities of long-term debt 2.1 2.8
Deferred revenues 7.4 9.1
Deferred tax liabilities 0.5 2.2
Operating lease liabilities 18.0 18.7
Other long-term liabilities 33.8 31.8
Commitments and contingencies (Note 12)
Stockholders' equity:
Preferred stock, $0.01 par value: 20,000,000 shares authorized, none issued — —
Accumulated other comprehensive income 0.1 —
Total Varex stockholders' equity 533.4 483.3
Noncontrolling interests 13.3 13.2
Total liabilities and stockholders' equity $ 1,184.4 $ 1,147.5
See accompanying Notes to Consolidated Financial Statements.
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VAREX IMAGING CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In millions) Shares Amount
Cumulative effect of accounting change — — — — (0.3) (0.3) — (0.3)
Exercise of stock options 0.1 — 1.5 — — 1.5 — 1.5
Common stock issued upon vesting of restricted shares 0.2 — — — — — — —
Shares withheld on vesting of restricted stock (0.1) — (1.8) — — (1.8) — (1.8)
Common stock issued under employee stock purchase plan 0.2 — 3.6 — — 3.6 — 3.6
Share-based compensation — — 13.4 — — 13.4 — 13.4
Unrealized gain on defined benefit obligations, net of tax — — — 0.6 — 0.6 — 0.6
Purchase of hedges — — (61.0) — — (61.0) — (61.0)
Foreign currency translation adjustments — — — 1.5 — 1.5 — 1.5
Shares issued to settle deferred consideration 0.3 — 7.4 — — 7.4 — 7.4
Common stock issued upon vesting of restricted shares 0.2 — — — — — — —
Shares withheld on vesting of restricted stock (0.1) — (1.5) — — (1.5) — (1.5)
Common stock issued under employee stock purchase plan 0.2 — 2.8 — — 2.8 — 2.8
Share-based compensation — — 13.9 — — 13.9 — 13.9
Foreign currency translation adjustments — — — (0.7) — (0.7) — (0.7)
Exercise of stock options 0.1 — 3.8 — — 3.8 — 3.8
Common stock issued upon vesting of restricted shares 0.4 — — — — — — —
Shares withheld on vesting of restricted stock (0.1) — (2.8) — — (2.8) — (2.8)
Common stock issued under employee stock purchase plan 0.3 — 4.9 — — 4.9 — 4.9
Share-based compensation — — 14.0 — — 14.0 — 14.0
Unrealized loss on forward contracts — — — (0.6) — (0.6) — (0.6)
Unrealized gain on defined benefit obligations, net of tax — — — 1.4 — 1.4 — 1.4
Foreign currency translation adjustments — — — (0.6) — (0.6) — (0.6)
See accompanying Notes to Consolidated Financial Statements.
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VAREX IMAGING CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Fiscal Years
Cash flows from operating activities:
Share-based compensation expense 14.0 13.9 13.4
Amortization of intangible assets 14.6 16.8 17.2
Loss from equity method investments 2.6 3.0 1.3
Amortization of deferred loan costs 10.9 10.0 5.1
Impairment of intangible assets — — 2.8
Other assets impairment charges — 0.5 2.7
Loss on operating lease abandonment 1.9 — —
Changes in assets and liabilities:
Prepaid expenses and other assets 10.3 (0.9) (9.3)
Accrued liabilities and other current and long-term liabilities (14.9) 12.2 8.1
Deferred revenues — 0.6 (2.0)
Net cash provided by operating activities 16.9 92.6 13.2
Cash flows from investing activities:
Purchases of property, plant and equipment (21.3) (15.1) (23.5)
Loss on settlement of cash flow hedge (0.5) — —
Proceeds from maturities of marketable debt securities 2.0 — —
Purchase of marketable debt securities (18.7) — —
Purchase of marketable equity securities (2.4) — —
Purchase of certificates of deposit (7.2) — —
Acquisitions of businesses, net of cash acquired — — (1.6)
Proceeds from sales of business and assets 1.7 — —
Investments in and loans to privately-held companies (0.6) (1.4) (1.8)
Net cash used in investing activities (48.4) (16.2) (26.9)
Cash flows from financing activities:
Proceeds from issuance of debt — 1.5 593.8
Payment of debt issuance costs — — (16.7)
Proceeds from issuance of warrant — — 49.8
Purchases of hedges — — (61.0)
Proceeds from shares issued under employee stock purchase plan 4.9 2.8 3.6
Proceeds from exercise of stock options 3.8 — 1.5
Taxes related to net share settlement of equity awards (2.8) (1.5) (1.8)
Other financing activities (0.3) (2.0) (1.7)
Net cash (used in) provided by financing activities (23.8) (32.3) 83.6
Supplemental cash flow information:
Cash paid for income tax, net of refunds 2.2 14.1 4.2
Supplemental non-cash activities:
See accompanying Notes to Consolidated Financial Statements.
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VAREX IMAGING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
Varex Imaging Corporation (the “Company,” “Varex,” or “Varex Imaging”) designs, manufactures, sells and services a broad range of medical products, which include X-ray components including tubes, digital detectors and accessories, high voltage connectors, image processing software and workstations, computer-aided diagnostic software, collimators, automatic exposure control devices, generators, ionization chambers and buckys, for use in a range of applications, including radiographic or fluoroscopic imaging, mammography, computed tomography, oncology and computer-aided detection. The Company sells its products to imaging system original equipment manufacturer (“OEM”) customers for incorporation into new medical diagnostic, radiation therapy, dental, and veterinary equipment, as well as to independent service companies and distributors, and directly to end-users for replacement purposes.
The Company also designs, manufactures, sells and services industrial products, which include Linatron® X-ray linear accelerators, digital detectors, high voltage connectors, imaging processing software and image detection products for security and inspection purposes, such as cargo screening at ports and borders and nondestructive examination in a variety of applications. The Company generally sells security and inspection products to OEM customers who incorporate Varex’s products into their inspection or irradiation systems and processes. The Company conducts an active research and development program to focus on new technology and applications in both the medical and industrial X-ray imaging markets.
Basis of Presentation
The accompanying consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the SEC and in accordance with accounting principles generally accepted in the United States ("GAAP"). The Company has consolidated all the majority owned subsidiaries and entities over which we have control. All intercompany balances and transactions have been eliminated in consolidation.
Segment Reporting
The Company has two reportable operating segments; (i) Medical and (ii) Industrial. See Note 16, Segment Information, included in this report, for further information on the Company’s segments.
Fiscal Year
The fiscal years of the Company as reported are the 52 or 53-week period ending on the Friday nearest September 30. Fiscal year 2022 was the 52-week period that ended September 30, 2022, fiscal year 2021 was the 52-week period that ended October 1, 2021, and fiscal year 2020 was the 53-week period that ended October 2, 2020.
Variable Interest Entities
For entities in which the Company has variable interests, the Company focuses on identifying which entity has the power to direct the activities that most significantly impact the variable interest entity’s economic performance and which entity has the obligation to absorb losses or the right to receive residual returns from the variable interest entity. If the Company is the primary beneficiary of a variable interest entity, the assets, liabilities and results of operations of the variable interest entity will be included in the Company’s consolidated financial statements. As of September 30, 2022, the Company had variable interests in two entities, neither of which were consolidated by the Company.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Such estimates include the valuation of inventories, valuation of goodwill and intangible assets, warranties, contract liabilities, long-lived asset valuations, impairment of investments, valuation of financial instruments, and taxes on income. Actual results could differ from these estimates.
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Impact of COVID-19
The coronavirus (“COVID-19”) pandemic, the emerging variants, uneven vaccination rates across the globe, and the mitigation efforts by governments to control its spread have created uncertainties and disruptions in the economic and financial markets. The extent to which COVID-19 will continue to impact the Company’s business and financial results depends on numerous evolving factors including: the magnitude and duration of COVID-19, the extent to which it will continue to impact worldwide macroeconomic conditions, including supply chain disruptions, interest rates, unemployment rates, the speed of the economic recovery, and governmental and business reactions to the pandemic. The Company has experienced continuing supply chain disruptions and other issues that are at least partially related to the ongoing COVID-19 pandemic. In addition, while we have from time to time taken significant precautions to maintain employee safety, such as implementing mask requirements, encouraging vaccination, and periodically asking non-production related employees to work from home when possible, the Company has experienced, and may in the future experience, COVID-19 related employee absences that adversely impact our production or business.
The Company assessed certain accounting matters that generally require consideration of forecasted financial information in context with the information reasonably available to the Company, including the estimated future impacts of COVID-19, through the date of filing this report. The accounting matters assessed included, but were not limited to, the Company’s carrying value of goodwill, intangibles, long-lived assets, equity method investments, inventory and related reserves, and the allowance for credit losses. The Company’s assessment of the magnitude and duration of COVID-19, as well as other factors, could result in material negative impacts to the Company’s consolidated financial statements in future reporting periods. These future developments are highly uncertain and the outcomes cannot be estimated with certainty. Actual results may differ from those estimates, and such differences may be material to the financial statements.
Cash and Cash Equivalents
The Company considers currency on hand, demand deposits, time deposits and all highly-liquid investments with an original maturity of three months or less at the date of purchase to be cash and cash equivalents.
Restricted Cash
Restricted cash primarily consists of cash collateral related to certain leases and inventory arrangements. Restricted cash is included in other assets on the Company's Consolidated Balance Sheets.Cash and cash equivalents and restricted cash as reported within the Consolidated Statements of Cash Flows consisted of the following:
Twelve Months Ended September 30, 2022 Twelve Months Ended October 1, 2021
FairValue
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. There is a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:
Level 1—Quoted prices in active markets for identical assets or liabilities.
Level 2—Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or, other inputs that are observable or can be corroborated by observable market data.
Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
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Derivative Instruments and Hedging Activities
The Company records all derivatives on the Consolidated Balance Sheets at fair value as of the reporting date. For derivative instruments that are designated and qualify as cash flow hedges, the gain or loss on the derivative is reported as a component of other comprehensive income or loss and reclassified from accumulated other comprehensive income ("OCI") into earnings when the hedged transaction affects earnings. For derivatives that are designated and qualify as net investment hedges, the gain or loss on the derivative is reported as a component of other comprehensive income or loss until the hedged item is sold. The portion of the change in fair value of the Company's net investment hedges (or cross currency swaps) related to the cross-currency basis spread is an excluded component in the assessment of the effectiveness of these net investment hedges (or cross currency swaps). A qualitative assessment of hedge effectiveness is performed on a quarterly basis, unless facts and circumstances indicate the hedge may no longer be highly effective, in which case, a quantitative assessment of hedge effectiveness is performed.
Concentration of Risk
Financial instruments that potentially expose the Company to concentrations of credit risk consist principally of cash, cash equivalents, marketable securities, and trade accounts receivable. Cash held with financial institutions may exceed the Federal Deposit Insurance Corporation insurance limits or similar limits in foreign jurisdictions. To date, the Company has not experienced any losses on its deposits of cash and cash equivalents. The Company performs ongoing credit evaluations of its customers and, except for government tenders, group purchases and orders with a letter of credit, its industrial customers often provide a down payment. The Company maintains an allowance for credit losses based upon the expected collectability of all accounts receivable. The Company obtains some of the components in its products from a limited group of suppliers or from a single-source supplier. When these suppliers are unable to meet the Company's supply needs, the Company's production is negatively impacted.
Credit is extended to customers based on an evaluation of the customer’s financial condition, and collateral is not required. In certain circumstances, a customer may be required to prepay all or a portion of the contract price prior to transfer of control. During the periods presented, one of the Company's customers accounted for a significant portion of revenues, as set forth below:
Fiscal Year
Canon Medical Systems Corporation 17.2 % 17.9 % 20.5 %
Canon Medical Systems Corporation accounted for 10.3% and 16.2% of the Company’s accounts receivable as of September 30, 2022 and October 1, 2021, respectively.
Inventories, net
Inventory is valued at the lower of cost or net realizable value. Costs include materials, labor, external service and manufacturing overhead and is computed on a first-in-first-out basis. The Company evaluates the carrying value of its inventories taking into consideration such factors as historical and anticipated future sales compared to quantities on hand and the prices the Company expects to obtain for products in its various markets. The Company adjusts excess and obsolete inventories to net realizable value and write-downs of excess and obsolete inventories are recorded as a component of cost of revenues.
The following table summarizes the Company’s inventories, net:
The Company recorded inventory write-downs of $6.4 million, $3.5 million and $18.1 million for the twelve months ended September 30, 2022, October 1, 2021 and October 2, 2020, respectively, of which $0.0 million, $3.5 million, and $15.8 million were from certain discontinued products in relation to COVID-19.
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Property, Plant and Equipment, net
Property, plant and equipment are stated at cost, net of accumulated depreciation. Major improvements are capitalized, while repairs and maintenance are expensed as incurred. Depreciation is computed using the straight-line method over the estimated useful lives of the assets or remaining lease term. Land is not subject to depreciation, but land improvements are depreciated over fifteen years. Land leasehold rights and leasehold improvements are depreciated over the lesser of their estimated useful lives or remaining lease terms. Buildings are depreciated up to thirty years. Machinery and equipment are depreciated over a range from three to seven years. Assets subject to lease are depreciated over the lesser of their estimated useful lives or remaining lease terms. Estimated useful lives are periodically reviewed and, when appropriate, changes are made prospectively. When certain events or changes in operating conditions occur, asset lives may be adjusted, and an impairment assessment may be performed on the recoverability of the carrying amounts. When assets are retired or otherwise disposed of, the assets and related accumulated depreciation are removed from the accounts.
The following table summarizes the Company’s property, plant and equipment, net:
Buildings and leasehold improvements 149.2 148.7
Construction in progress 29.1 18.1
Gross property, plant and equipment 369.5 354.8
Accumulated depreciation and amortization (228.2) (214.6)
Total property, plant and equipment, net $ 141.3 $ 140.2
The Company recorded depreciation expense of $19.0 million, $20.5 million and $22.3 million in fiscal years 2022, 2021 and 2020, respectively. During fiscal years 2022, 2021 and 2020, the Company recorded accelerated depreciation of $0.0 million, $0.2 million and $2.9 million, respectively, which primarily related to the machinery and equipment used at the Santa Clara, California facility. See Note 5, Restructuring, included in this report, for further information.
Investments
The Company accounts for its equity investments in privately-held companies under the equity method of accounting if the Company has the ability to exercise significant influence in these investments. Distributions received from an equity method investment are classified using the cumulative earnings approach, which means that distributions up to the amount of cumulative equity in earnings recognized will be treated as returns on investment and classified as operating cash flows and those in excess of that amount will be treated as returns of investment and classified as investing cash flows. The Company reviews its equity investments in privately-held companies for impairment whenever events or changes in business circumstances are other than temporary and indicate that the carrying amount of the investments may not be fully recoverable. There were no impairments recorded during fiscal years 2022 and 2021. During the fiscal year 2020, the Company wrote off a $2.7 million cost investment in a privately-held company, the related expense is included as part of other expense, net in the Company's consolidated financial statements.
Marketable Securities
The Company's marketable securities consist primarily of financial instruments such as U.S. treasury securities, U.S. agency obligations, corporate bonds, commercial paper, money market funds, and equity securities. The Company classifies marketable debt securities as available-for-sale at the time of purchase and reevaluates such classifications as of each balance sheet date. All marketable debt securities are recorded at estimated fair value. Any unrealized gains or losses for marketable debt securities are included in accumulated other comprehensive income within the Consolidated Balance Sheets. Marketable equity securities are stated at fair value as determined by the most recently traded price of each security at the balance sheet date. All unrealized gains and losses on equity securities are recorded as part of other expense, net in the Company's consolidated financial statements. See Note 10, Fair Value, for further details.
When the fair value of a debt security declines below its amortized cost basis, any portion of that decline attributable to credit losses, to the extent expected to be nonrecoverable before the sale of the security, is recognized in our Consolidated Statements of Operations. When the fair value of a debt security declines below its amortized cost basis due to changes in interest rates, such amounts are recorded in accumulated other comprehensive income, and are recognized in our Consolidated Statements of Operations only if we sell or intend to sell the security before recovery of its cost basis. There were no credit losses related to marketable debt securities recorded during the twelve months ended September 30, 2022.
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Goodwill and Intangible Assets
Goodwill is recorded when the purchase price of an acquisition exceeds the fair value of the net identified tangible and intangible assets acquired. Purchased intangible assets are carried at cost, net of accumulated amortization, and are included in intangible assets, net in the Company's Consolidated Balance Sheets. Intangible assets with finite lives are amortized over their estimated useful lives of primarily two to seven years using the straight-line method.
Impairment of Long-lived Assets, Intangible Assets and Goodwill
The Company reviews long-lived assets and identifiable intangible assets with finite lives for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. The Company assesses these assets for impairment based on their estimated undiscounted future cash flows. If the carrying value of the assets exceeds the estimated future undiscounted cash flows, the Company recognizes an impairment loss based on the excess of the carrying amount over the fair value of the assets.
The Company evaluates goodwill and indefinite lived intangible assets for impairment at least annually at the beginning of the fourth quarter of each fiscal year or whenever an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The evaluation includes consideration of qualitative factors including industry and market considerations, overall financial performance, and other relevant events and factors affecting the reporting unit. If the Company determines that a quantitative analysis is necessary, the Company performs a step one analysis, which consists of a comparison of the fair value of a reporting unit against its carrying amount, including the goodwill allocated to each reporting unit. The Company determines the fair value of its reporting units based on a combination of income and market approaches. The income approach is based on the present value of estimated future cash flows of the reporting units, and the market approach is based on a market multiple calculated for each reporting unit based on market data of other companies engaged in similar business. If the carrying amount of the reporting unit is in excess of its fair value, the difference between the fair value and carrying amount is recorded as an impairment loss. The impairment test for intangible assets with indefinite useful lives, if any, consists of a comparison of fair value to carrying value, with any excess of carrying value over fair value being recorded as an impairment loss. In fiscal years 2022, 2021 and 2020, the Company performed the annual goodwill impairment test for our two reporting units and found no impairment.
During the fiscal years ended September 30, 2022, October 1, 2021 and October 2, 2020, the Company recognized $0.0 million, $0.0 million, and $2.8 million of impairments of intangible assets, respectively.
Loss Contingencies
From time to time, the Company is involved in legal proceedings, claims and government inspections or investigations, customs and duties audits, other contingency matters, both inside and outside the United States, arising in the ordinary course of its business or otherwise. The Company accrues amounts for probable losses, to the extent they can be reasonably estimated, that it believes are adequate to address any liabilities related to legal proceedings and other loss contingencies that the Company believes will result in a probable loss (including, among other things, probable settlement value). A loss or a range of loss is disclosed when it is reasonably possible that a material loss will be incurred and can be estimated or when it is reasonably possible that the amount of a loss, when material, will exceed the recorded provision. When a loss contingency is probable but not reasonably estimable the nature of the contingency and the fact that an estimate cannot be made is disclosed. See Note 12, Commitments and Contingencies, for further information regarding certain of our contractual obligations and contingencies.
Product Warranty
The Company warrants most of its products for a specific period of time, usually 12 to 24 months from delivery or acceptance, against material defects. The Company provides for the estimated future costs of warranty obligations in cost of revenues when the related revenues are recognized. The accrued warranty costs represent the best estimate at the time of sale of the total costs that the Company will incur to repair or replace product parts that fail while still under warranty.
The amount of the accrued estimated warranty costs obligation for established products is primarily based on historical experience as to product failures adjusted for current information on repair costs. For new products, estimates include the historical experience of similar products, as well as a reasonable allowance for warranty expenses associated with new products. On a quarterly basis, the Company reviews the accrued warranty costs and updates the historical warranty cost trends, if required.
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The following table reflects the changes in the Company’s accrued product warranty:
Fiscal Years Ended
Accrued product warranty, at beginning of period $ 8.5 $ 8.1
New accruals charged to cost of revenues 11.3 13.0
Product warranty expenditures (11.9) (12.6)
Accrued product warranty, at end of period $ 7.9 $ 8.5
Leases
The Company determines if an arrangement is or contains a lease at the inception of an arrangement. The Company's operating lease right-of-use ("ROU") assets represent the right to use an underlying asset over the lease term and lease liabilities represent its obligation to make lease payments arising from the lease. ROU assets may also include initial direct costs incurred and prepaid lease payments, less lease incentives. Lease liabilities and their corresponding ROU assets are recognized based on the present value of lease payments over the lease term, discounted using the Company's incremental borrowing rate. The Company recognizes operating leases with lease terms of more than twelve months in operating lease assets, current operating lease liabilities, and operating lease liabilities on its Consolidated Balance Sheets. The Company recognizes finance leases with lease terms of more than twelve months in property, plant and equipment, net, accrued liabilities and other current liabilities, and other long-term liabilities on its Consolidated Balance Sheets. For purposes of calculating lease liabilities and the corresponding ROU assets, the Company's lease term may include options to extend or terminate the lease when it is reasonably certain that it will exercise that option.
Revenue Recognition
The Company’s revenues are derived primarily from the sale of hardware and services. The Company recognizes its revenues net of any value-added or sales tax and net of sales discounts.
The Company sells a high proportion of its X-ray products to a limited number of OEM customers. X-ray tubes, digital detectors and image-processing tools and security and inspection products are generally sold on a stand-alone basis. However, the Company occasionally sells its digital detectors, X-ray tubes and imaging processing tools as a package that is optimized for digital X-ray imaging and sells its Linatron ® X-ray accelerators together with its imaging processing software and image detection products to OEM customers that incorporate them into their inspection systems. Service contracts are often sold with certain security and inspection products and computer-aided detection products.
The Company determines revenue recognition through the following steps:
•Identification of the contract, or contracts, with a customer
•Identification of the performance obligations in the contract
•Determination of the transaction price
•Allocation of the transaction price to the performance obligations in the contract
•Recognition of revenue when, or as, a performance obligation is satisfied
Transaction Price and Allocation to Performance Obligations
Transaction prices of products or services are typically based on contracted rates. To the extent that the transaction price includes variable consideration, the Company estimates the amount of variable consideration that should be included in the transaction price utilizing the expected value method when there is a large number of transactions with similar characteristics or the most likely amount method when there are two possible outcomes, depending on the circumstances of the transaction, to which the Company expects to be entitled. Variable consideration is included in the transaction price if, in the Company’s judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur. Estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of the Company’s anticipated performance and all information (historical, current and forecasted) that is reasonably available.
The Company allows customers to return specific parts of purchased X-ray tubes for a partial refund credit, which is identified as variable consideration. For sales with a right of return, revenue is reduced for expected returns, a liability is recorded for expected returns, and an asset is recorded for the right to recover products from customers on settling the liability. The Company recognizes a reduction to revenue and cost of sales at the time of sale and a corresponding contract liability and contract asset. The Company records this estimate based on the historical volume of product returns and adjusts the estimate on a quarterly basis based on the current quarter sales and current quarter returns.
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If a contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price based on the estimated relative standalone selling prices of the promised products or services underlying each performance obligation. The Company determines standalone selling prices based on the price at which the performance obligation is sold separately.
Contracts and Performance Obligations
The Company accounts for a contract with a customer when there is an approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of the consideration is probable. The Company's performance obligations consist mainly of transferring control of products and services identified in the contracts or purchase orders. For each contract, the Company considers the obligation to transfer products and services to the customer, which are distinct, to be performance obligations.
Recognition of Revenue
Revenue is recognized when, or as, obligations under the terms of a contract are satisfied, which occurs when control of the promised products or services is transferred to customers. Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring products or services to a customer.
Product revenue is generally recognized when the customer obtains control of the Company’s product, which occurs at a point in time, and may be upon shipment or upon delivery based on the contractual shipping terms of a contract.
Service revenue is generally recognized over the term of the service contract. Services are expected to be transferred to the customer throughout the term of the contract and the Company believes recognizing revenue ratably over the term of the contract best depicts the transfer of value to the customer.
Disaggregation of Revenue
Revenue is disaggregated from contracts between geography and by reportable operating segment, which the Company believes best depicts how the nature, amount, timing, and uncertainty of revenues and cash flows are affected by economic factors. Refer to Note 16, Segment Information, included in this report, for the disaggregation of the Company’s revenue based on reportable operating segments and disaggregated by geographic region.
Contract Balances
Contract assets are included within the prepaid expenses and other current assets, and other assets balances in the Consolidated Balance Sheets. Contract liabilities, which also includes refund obligations, are included within the accrued liabilities and other current liabilities, deferred revenues, and other long-term liabilities balances in the Consolidated Balance Sheets.
Costs to Obtain or Fulfill a Customer Contract
The Company has certain costs to obtain and fulfill a customer contract, such as commissions and shipping costs. The Company recognizes the incremental costs of obtaining contracts as an expense when incurred if the amortization period of the assets that the Company otherwise would have recognized is one year or less. Incremental costs of obtaining contracts that would be recognized over greater than one year are not material. The Company accounts for shipping and handling activities related to contracts with customers as costs to fulfill the promise to transfer the associated products. These costs are included as a component of cost of revenues.
Deferred Revenues
Deferred revenue primarily represents (i) the amount received applicable to non-software products for which parts and services under the warranty contracts have not been delivered, and (ii) the amount received for service contracts for which the services have not been rendered.
Allowance for Credit Losses
The Company evaluates the creditworthiness of customers prior to authorizing shipment for all major sale transactions. On a quarterly basis, the Company considers historical trends, current information and any reasonable and supportable forecasts to determine if an amount should be included in the allowance for credit losses. The Company had an allowance for credit losses of $0.6 million and $1.0 million as of September 30, 2022 and October 1, 2021, respectively.
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Share-Based Compensation Expense
The Company has an equity-based incentive plan that provides for the grant of nonqualified stock options and restricted stock units to directors, officers and other employees. The Company also permits employees to purchase shares under the Varex employee stock purchase plan.
The Company values stock options granted and the option component of the shares of common stock purchased under the equity-based incentive plans and stock purchased under the employee stock purchase plan using the Black-Scholes option-pricing model. Share-based compensation expense for restricted stock units is measured using the fair value of the Company’s stock on the date of grant and is amortized over the award’s respective service period. The Black-Scholes option-pricing model requires the input of certain assumptions, and changes in the assumptions can materially affect the fair value estimates of share-based payment awards.
The Company measures and recognizes expense for all share-based payment awards based on their fair values. Share-based compensation expense recognized in the Consolidated Statements of Operations includes compensation expense for the share-based payment awards based on the grant date fair value estimated in accordance with the guidance on share-based compensation. The Company records forfeitures as they occur. The Company attributes the value of share-based compensation to expense using the straight-line method. The Company considers only the direct tax impacts of share-based compensation awards when calculating the amount of tax windfalls or shortfalls. For additional information, see Note 14, Employee Stock Plans, included in this report.
Software Development Costs
Costs for the development of new software products and substantial enhancements to existing software products are expensed as incurred until technological feasibility has been established, at which time any additional costs would be capitalized. No costs associated with the development of software have been capitalized as the Company believes its current software development process is essentially completed concurrent with the establishment of technological feasibility.
Research and Development
Research and development costs are expensed as incurred. These costs primarily include employees’ compensation, consulting fees and material costs.
Taxes on Income
Current income tax expense or benefit is the amount of income taxes expected to be payable or receivable for the current year. Deferred income tax liabilities or assets are established for the expected future tax consequences resulting from the differences in financial reporting and tax bases of assets and liabilities. Future changes in tax regulation can have a material impact, including tax rate changes or the realization of deferred tax assets. A valuation allowance is provided if it is more likely than not that some or all of the deferred tax assets will not be realized. U.S. tax reform introduced a limitation of business interest deduction under IRC Section 163(j), which may be difficult to utilize without significant taxable income. Also, net operating loss carryforwards in jurisdictions with current losses provide uncertainty for realization. In addition, we provide reserves for uncertain tax positions when such tax positions do not meet the recognition thresholds or measurement standards prescribed by the authoritative guidance for accounting for income taxes. A portion of the U.S. general business tax credits for research outside of the financial statement line for research and development ("R&D") have a small degree of uncertainty. A reasonable reserve is maintained on the uncertain portion until either the Internal Revenue Service chooses to audit or the statute of limitation expires. A reserve for R&D is typical for companies that calculate and utilize this general business credit. Amounts for uncertain tax positions are adjusted in periods when new information becomes available or when positions are effectively settled. Interest and penalties related to uncertain tax positions are recognized as a component of income tax expense.
During fiscal year 2022, the Company received cash tax refunds related to net operating loss ("NOL") carryback claims for U.S. losses incurred in fiscal year 2020. On August 16, 2022, the Inflation Reduction Act was enacted in response to rising inflation. The Company does not meet the financial statement thresholds for the minimum tax applicability and does not anticipate other provisions will have a material impact. The 2017 Tax Cuts and Jobs Act ("TCJA") included a provision requiring research and development expenditures to be capitalized for tax years beginning after December 31, 2021, which will be effective for the Company starting in fiscal year 2023. Because the Company has a significant amount of research and development expenditures, it expects increased cash taxes in the early years following the effective date of TCJA.
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Foreign Currency Translation
The Company uses the U.S. Dollar predominately as the functional currency of its foreign operations. Gains and losses from remeasurement of foreign currency balances into U.S. Dollars are included in the Consolidated Statements of Operations in other expense, net. For the foreign subsidiaries where the local currency is the functional currency, translation adjustments of foreign currency financial statements into U.S. Dollars are recorded to a separate component of accumulated other comprehensive income.
Recently Adopted Accounting Pronouncements
In December 2019, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2019-12, Simplifying the Accounting for Income Taxes, which simplifies the accounting for income taxes by removing certain exceptions to the current guidance, and improving the consistent application and simplification of other areas of the guidance. The Company adopted this ASU on October 2, 2021, using a prospective approach. The adoption of ASU 2019-12 did not have a material impact on the Company's consolidated financial statements and related disclosures.
In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments. This pronouncement changes the impairment model for most financial assets and certain other instruments, including trade and other receivables, held-to-maturity debt securities and loans and replaces the incurred loss methodology with a new, forward-looking “expected loss” model that considers the risk of loss over the asset’s contractual life, even if remote, historical experience, current conditions, and reasonable and supportable forecasts of future relevant events. The Company adopted this ASU on October 3, 2020, using a modified retrospective approach. The adoption of ASU 2016-13 did not have a material impact on the Company's consolidated financial statements and related disclosures.
Recent Accounting Standards Updates Not Yet Effective
In August 2020, the FASB issued ASU 2020-06, Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. The standard removes certain separation models in ASC 470-20 for convertible instruments, and, as a result, embedded conversion features are no longer separated from the host contract for convertible instruments with conversion features that are not required to be accounted for as derivatives under ASC 815. These convertible debt instruments will be accounted for as a single liability measured at amortized cost. This will also result in the interest expense recognized for convertible debt instruments to be typically closer to the coupon interest rate. Further, the ASU made amendments to the earnings per share (“EPS”) guidance in Topic 260 for convertible instruments, the most significant impact of which is requiring the use of the if-converted method for diluted EPS calculation, and no longer allowing the net share settlement method. The ASU is effective for annual periods beginning after December 15, 2021, including interim periods within those years. Adoption of the ASU can either be on a modified retrospective or full retrospective basis. The Company will adopt the new standard effective October 1, 2022, the first day of the fiscal year ending September 29, 2023, using the modified retrospective method. On the date of adoption, the Company estimates that its entry to adopt this ASU will be to record a reduction in additional paid-in capital of $34.6 million, an increase to long-term debt, net of $28.0 million, an increase to deferred tax assets of $6.7 million, and an increase to retained earnings of $13.3 million in 2023 for the after-tax impact of previously recognized amortization of the debt discount associated with the Company’s Convertible Senior Notes. The unamortized discount on our Convertible Notes (see Note 9, Borrowings) will be reclassified from equity to liabilities and the interest expense from our Convertible Notes will decrease and be closer to the coupon rate of 4.00%. The impact that adoption of ASU 2020-06 will have on our net income per diluted share will depend on the amount of earnings in each period and our share price, and could result in additional dilution.
In March 2020, the FASB issued ASU 2020-04, Facilitation of the Effects of Reference Rate Reform on Financial Reporting, to provide optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate (e.g., LIBOR) reform on financial reporting. Adoption of the guidance is elective and is permitted from March 12, 2020 through December 31, 2022. The Company will evaluate transactions or contract modifications occurring as a result of reference rate reform and determine whether to apply the optional guidance on an ongoing basis. The Company determined this ASU will not have a material impact on its financial position, results of operations or cash flows.
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2. REVENUE RECOGNITION
The following tables summarize the changes in the contract assets and refund liabilities for the twelve months ended September 30, 2022 and October 1, 2021:
(In millions) Contract Assets
Costs recovered from product returns during the period (4.8)
Adjustment for actual vs. reserved product returns (1.9)
Costs recovered from product returns during the period (5.4)
Adjustment for actual vs. reserved product returns (0.6)
(In millions) Refund Liabilities
Release of refund liability included in beginning of year refund liability (5.3)
Additions to refund liabilities 7.1
Adjustment for actual vs. reserved product returns (2.2)
Release of refund liability included in beginning of year refund liability (6.1)
Additions to refund liabilities 7.9
Adjustment for actual vs. reserved product returns (0.6)
During fiscal year 2022, the Company recognized revenue of $6.7 million related to deferred revenue which existed at October 1, 2021. During fiscal year 2021, the Company recognized revenue of $6.9 million related to deferred revenue which existed at October 2, 2020.
Remaining Performance Obligations
Remaining performance obligations represent the transaction price of firm orders for which revenue has not yet been recognized, which are primarily related to contracts where control will be transferred to customers over the next 12 months. See Note 1, Summary of Significant Accounting Policies, for details on the nature of the remaining performance obligations within these contracts and how they will be resolved.
3. LEASES
On September 28, 2019, the Company adopted ASC 842, which amended the guidance for the accounting and reporting of leases. The determination of whether an arrangement is, or contains, a lease is performed at the inception of the arrangement. The Company has operating and finance leases for office space, warehouse and manufacturing space, vehicles, and certain equipment. The Company's lease agreements do not contain any material residual value guarantees, variable lease costs, bargain purchase options or restrictive covenants. The Company does not have any lease transactions with related parties. Leases with an initial term of 12 months or less are generally not recorded on the balance sheet and expense for these leases is recognized on a straight-line basis over the lease term. The Company's leases have remaining lease terms of less than one year to approximately ten years, some of which may include options to extend the leases for up to five years and some include options to terminate early. These options have been included in the determination of the lease liability when it is reasonably certain that the option will be exercised.
Right-of-use assets represent the Company's right to use an underlying asset for the lease term, and lease liabilities represent the Company's obligation to make lease payments arising from the lease contract. Operating lease liabilities and their corresponding right-of-use assets are recorded based on the present value of fixed lease payments over the expected lease term. The interest rate implicit in lease contracts is typically not readily determinable. As such, the Company's incremental borrowing rate is based on a credit-adjusted risk-free rate, which best approximates a secured rate over a similar term of lease.
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