Varex Imaging Corp (VREX) FY 2024 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis contain 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 imaging components including X-ray tubes, flat panel and photon counting detectors and accessories, linear accelerators, and image software processing solutions, which

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are critical components of a variety of X-ray based imaging equipment, and stand-alone X-ray based systems in select application areas. Our success depends, among other things, on our ability to anticipate and respond to changes in our business, the direction of technological innovation, and the demand from our customers. For additional information on our business, see Item 1 "Business".

Impact of General Economic Environment

We remain cautious about the general economic environment as many factors remain dynamic and unpredictable. The uncertain economic and geopolitical environment, supply chain and logistic challenges, and geopolitical tensions and local conflicts have contributed to, and may continue to contribute to, inflation, higher interest rates and capital costs, increased shipping costs, supply shortages, increased costs of labor and materials, exchange rate volatility, increased tariffs, and other similar effects.

We experienced fewer supply chain, manufacturing, and logistics challenges in fiscal year 2024 than in fiscal year 2023. However, shortages of certain materials and delivery delays from some suppliers caused, and may in the future cause, delays in manufacturing products, as well as operational and customer order fulfillment challenges. In addition, since late 2023 our Medical business has been negatively impacted by the Chinese government's anti-corruption campaign related to the healthcare industry, which we expect to continue at some level through fiscal year 2025. We continue to observe cautious purchasing behaviors by our customers, which we expect to subside by calendar year-end 2024. The impact to our business from potential changes to tariffs as a result of the outcome of the recent United States presidential and congressional elections is unknown at this time. We continue to monitor developments in this area.

For additional information on risks related to supply chain and logistics challenges, cost increases, changes in U.S. and worldwide economic conditions, geopolitical tensions, and other risks that could impact our results, see 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 2024 was the 52-week period that ended September 27, 2024, fiscal year 2023 was the 52-week period that ended September 29, 2023, and fiscal year 2022 was the 52-week period that ended September 30, 2022.

Results of Operations

For a discussion and analysis of our year-over-year changes, financial condition, and results of operations for the fiscal years ended September 29, 2023 and September 30, 2022 refer to Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our annual report on Form 10-K for the fiscal year ended September 29, 2023, filed with the SEC on November 16, 2023. Our year-over-year changes, financial condition, and results of operations for the fiscal years ended September 27, 2024 and September 29, 2023 are set forth below.

Comparison of Results of Operations for Fiscal Years 2024 and 2023

Revenues, net

Medical revenues decreased $91.6 million in fiscal year 2024 compared to 2023 primarily due to lower sales in our China business, as well as decreased sales of fluoroscopy, oncology, and dental applications.

Industrial revenues increased $9.2 million due to increased sales of security inspection products and industrial tubes.

Revenues by Region

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The Americas revenues decreased $15.3 million in fiscal year 2024 compared to 2023 primarily due to decreased sales of digital detectors. EMEA revenues decreased $10.4 million primarily due to decreased sales of digital detectors, partially offset by increased sales in security inspection products. APAC revenues decreased $56.7 million primarily due to decreased sales of X-ray tubes and digital detectors.

Gross Profit

The Medical segment gross profit decreased $28.8 million in fiscal year 2024 compared to 2023 primarily due to lower volumes of X-ray tubes and digital detectors.

The Industrial segment gross profit decreased $4.6 million in fiscal year 2024 compared to 2023 primarily as a result of decreased volumes of digital detectors, partially offset by an increase in the sale of security inspection products.

Operating Expenses

Research and Development

Research and development costs for fiscal year 2024 increased to 10.7% of revenues primarily due to increased spending on material costs supporting research, partially offset by decreased development initiatives costs in the current fiscal year when compared to the prior fiscal year. 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 increased to 17.0% for fiscal year 2024 from 14.4% for fiscal year 2023 primarily due to decreased revenue, increased fixed cost commitments to a supplier, increased litigation costs, and increased severance costs, partially offset by lower intangible asset amortization expense.

Interest and Other Expense, Net

The following table summarizes our interest and other expense, net:

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Interest income increased in fiscal year 2024 compared to fiscal year 2023 primarily due to an increase in the average balance of investments in marketable debt securities during fiscal year 2024 when compared to the average balance during fiscal year 2023.

Interest expense increased in fiscal year 2024 compared to fiscal year 2023 primarily due to the termination of the ABL facility which resulted in the recognition of $0.6 million of the remaining unamortized deferred issuance costs.

Other expense, net decreased in fiscal year 2024 compared to fiscal year 2023 primarily due to a gain on business acquisition and decreased losses in certain investments in privately-held companies and equity investments, partially offset by increased foreign exchange expense.

Taxes on Income

We had an income tax expense of $52.2 million and an income tax benefit of $17.4 million, resulting in effective rates of 1,044.0% and (55.6)%, for fiscal years 2024 and 2023, respectively.

During fiscal year 2024, 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 a valuation allowance is provided as well as profit in foreign jurisdictions with statutory tax rates greater than 21%. These unfavorable items were partially offset by the favorable impact of U.S. tax reform regarding international provisions, R&D credits, and return to provision adjustments.

During fiscal year 2023, our effective tax rate varied from the U.S. federal statutory rate of 21% primarily due to the favorable impact of the release of the U.S. valuation allowance, U.S. tax reform regarding international provisions, R&D credits, and return to provision adjustments. These favorable items were partially offset by the unfavorable impact of profit in foreign jurisdictions with statutory tax rates greater than 21%.

We estimated the fiscal year 2024 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 2024 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 believe that our operating cash flow, cash on our balance sheet, availability under our Revolving Credit Facility and Equipment Credit Facility, and our ability to access the credit and capital markets are sufficient to meet our anticipated operating activities and cash commitments 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-term 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 a material change to our liquidity needs during or beyond the next 12 months, except for $200.0 million of our Convertible Notes that become due in June 2025 that we currently anticipate refinancing using some combination of future borrowings under our Revolving Credit Facility and cash. The availability under our Revolving Credit Facility and Equipment Credit Facility is $155.0 million and $20.0 million, respectively. As of September 27, 2024, our Revolving Credit Facility and Equipment Credit Facility remain undrawn. At September 27, 2024 we had total debt of $443.4 million, net of discounts and deferred issuance costs of $3.2 million.

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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:

Borrowings

The following table summarizes the changes in our debt outstanding:

Cash Flows

Net cash provided by operating activities. Net cash provided by operating activities was $47.3 million and $108.4 million for the fiscal years 2024 and 2023, respectively. The decrease in cash provided by operating activities was primarily due to a decrease in net income and a decrease in cash inflows for inventory and prepaid expenses and other assets, partially offset by decreased payments for accounts payable during fiscal year 2024.

Net cash used in investing activities. Cash used in investing activities was $27.5 million and $44.9 million for the fiscal years 2024 and 2023, respectively. The decrease in cash used in investing activities was primarily due to increased proceeds from the

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maturities of marketable debt securities, partially offset by increased purchases of marketable securities, increased purchases of property, plant, and equipment, and the settlement of net investment hedges in the prior year.

Net cash used in financing activities. Net cash used in financing activities was $3.3 million and $0.2 million for the fiscal years 2024 and 2023, respectively. The decrease in cash used in financing activities was primarily due to increased cash payments related to debt issuance costs and taxes for net share settlement of equity awards, partially offset by reduced repayments of borrowings when compared to fiscal year 2023.

Days Sales Outstanding

Trade accounts receivable days sales outstanding (“DSO”) was 70 days and 65 days at September 27, 2024 and September 29, 2023, respectively. Our accounts receivable and DSO are impacted by a number of factors, including the timing of product shipments, collections performance, payment terms, the mix of revenues from different regions and the effects of economic instability.

Material Contractual Obligations

The following table summarizes, as of September 27, 2024, the total amount of future payments due in various future periods:

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 the Consolidated Financial Statements.

For further discussion regarding our borrowings, see Note 9, Borrowings, included in the accompanying Notes to the 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 2024, we estimate that we have fixed cost commitments of $3.1 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 27, 2024, noncontrolling shareholders together held approximately 0.5 million shares of MeVis, representing 26.3% of the outstanding shares.

In the fourth quarter of fiscal year 2022, we entered into a development agreement and a share purchase agreement with a third-party company. For more information about these agreements, see Note 13, Commitments and Contingencies, included in the accompanying Notes to the Consolidated Financial Statements.

The Company enters into purchase agreements with its suppliers in the ordinary course of its business for the purchase of goods and services. Some of these purchase agreements are non-cancellable and thus contractually obligate us to future cash payments.

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Our operations and facilities, past and present, are subject to environmental laws, including laws that regulate the handling, storage, transport and disposal of hazardous substances. Certain of those laws impose cleanup liabilities under certain circumstances. In connection with those laws and certain of our past and present operations and facilities, we are obligated to indemnify Varian for the cleanup liabilities related to prior corporate restructuring activities. As of September 27, 2024, our estimated environmental liability for these sites is $3.9 million, net of expected insurance proceeds. For further discussion regarding our environmental obligation, see Note 1, Summary of Significant Accounting Policies, included in the accompanying Notes to the 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 our 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 27, 2024 and September 29, 2023. Legal expenses are expensed as incurred.

See Item 3 "Legal Proceedings" of this Annual Report for additional information regarding legal proceedings and Note 13, Commitments and Contingencies, in the Notes to the Consolidated Financial Statements for further information regarding certain of our contractual obligations and contingencies, which discussion is incorporated herein by reference.

Critical Accounting 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 the Consolidated Financial Statements, Item 8 "Financial Statements and Supplementary Data" describes the significant accounting policies and methods used in the preparation of the Company’s consolidated financial statements. 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 review inventory quantities on hand and record provisions for estimated excess, slow moving, and obsolete inventory. The evaluation of the carrying value of our inventories takes 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 businesses. 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. See Note 1, Summary of Significant Accounting Policies, "Inventories, net" for further details.

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

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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.

In fiscal years 2023 and 2022, we performed the annual goodwill qualitative impairment test for our two reporting units and determined that, at those times, it was not more likely than not that the fair values of the reporting units were less than their carrying amounts and accordingly recorded 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). Significant changes in our projections of our operating results or other factors could cause us to make interim assessments of impairment in any quarter that could result in some or all of the goodwill being impaired. A future impairment charge for goodwill could have a material effect on the Company's consolidated financial position and results of operations.

In the fourth quarter of 2024, changes in facts and circumstances related to reduced demand of the Company's medical products, coupled with a sustained decrease in the Company's stock price, resulted in the Company determining that an indicator of possible impairment existed within its reporting units. Accordingly, the Company performed a quantitative impairment analysis to determine the fair values of those reporting units, using both an income approach utilizing the discounted cash flow method and market approach utilizing the public company market multiple method. Based on the output of the analysis, the Company determined that the fair values of both the Medical and Industrial reporting units exceeded their carrying amounts. Accordingly, no impairment charges were recorded during the year ended September 27, 2024.

Taxes on Income

We calculate income taxes based on the tax statutes, regulations, and case law of the various jurisdictions in which we operate. Significant judgment is required in determining the timing and amounts of deductible and creditable items. The benefits of uncertain tax positions are recorded in our financial statements only after determining it is more likely than not that the uncertain tax positions would withstand challenge by taxing authorities. We periodically reassess our positions and record any changes in the financial statements as appropriate. Gross uncertain tax positions, exclusive of interest and penalties, were $1.6 million and $1.4 million as of September 27, 2024, and September 29, 2023, respectively. We believe the resolution of these matters will not materially affect our consolidated financial statements. Income taxes are described further in Note 16, Taxes on Income, in our Notes to the Consolidated Financial Statements.

The assessment regarding whether a valuation allowance is required or should be adjusted is based on an evaluation of possible sources of taxable income and also considers all available positive and negative evidence factors. Our accounting for the valuation of deferred tax assets represents our best estimate of future events. Changes in our current estimates, due to unanticipated business conditions, governmental legislative actions or events, could have a material effect on our ability to utilize deferred tax assets. The valuation allowance balances were $74.7 million and $18.7 million as of September 27, 2024 and September 29, 2023, respectively. Refer to Note 16, Taxes on Income, of our consolidated financial statements for additional information on the composition of valuation allowances.

Recent Accounting Standards or Updates Not Yet Effective

See Note 1, Summary of Significant Accounting Policies, of the Notes to the 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 27, 2024 was approximately $299 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.

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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.