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Item 2. Management’s Discussion and Analysis

2021-02-05 compared with 2020-08-14 · 148 added, 236 removed, 107 unchanged (78% of the section changed)

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of the financial condition and results should be read together with our Annual Report on Form 10-K for the fiscal year ended September 27, 2019.

The following discussion and analysis of the financial condition and results should be read together with the unaudited condensed consolidated financial statements and notes thereto that are contained in this Quarterly Report on Form 10-Q as well as our Annual Report on Form 10-K for the fiscal year ended October 2, 2020 and our other filings, including the Current Reports on Form 8-K, that have been filed with the SEC through the date of this report.

Forward-Looking Statements

This Quarterly Report on Form 10-Q (this “Quarterly Report”) contains “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995, which provides a “safe harbor” for statements about future events, products and future financial performance that are based on the beliefs of, estimates made by, and information currently available to the management of Varex Imaging Corporation (“we,” “our,” “us,” the “Company,” “Varex,” or “Varex Imaging”).

The outcome of the events described in these forward-looking statements are subject to risks and uncertainties (including the risks and uncertainties contained in Part II, Item 1A - Risk Factors of this Quarterly Report), and actual results and the outcome or timing of certain events may differ significantly from those projected in these forward-looking statements or management’s current expectations.

Actual results and the outcome or timing of certain events described in these forward-looking statements are subject to risk and uncertainties and may differ significantly from those projected in these forward-looking statements.

Important factors that could cause our actual results and financial condition to differ significantly from those projections or expectations include, among other things, the risks described in the Summary of Principal Risk Factors below and further described in the Risk Factors listed in Part II, Item 1A - Risk Factors of this Quarterly Report.

Statements concerning:

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future orders, revenues, backlog, earnings or other financial results;

liquidity and any statements using the terms “believe,” “expect,” “anticipate,” “can,” “should,” “would,” “could,” “estimate,” “may,” “intended,” “potential,” and “possible” or similar statements are forward-looking statements that involve risks and uncertainties that could cause our actual results and the outcome and timing of certain events to differ materially from those projected or management’s current expectations.

and any statements using the terms “believe,” “expect,” “anticipate,” “can,” “should,” “would,” “could,” “estimate,” “may,” “intended,” “potential,” and “possible” or similar statements are forward-looking statements that involve risks and uncertainties that could cause our actual results and the outcome and timing of certain events to differ materially from those projected or management’s current expectations.

Any forward-looking statement made in this Quarterly Report (including in any exhibits or documents incorporated by reference) is based only on information currently available to Varex and its management and speaks only as of the date on which it is made.

By making forward-looking statements, we have not assumed any obligation to, and you should not expect us to, update or revise those statements because of new information, future events or otherwise, including the impact of the COVID-19 pandemic and the responses to it.

Varex Imaging Corporation is a leading innovator, designer and manufacturer of X-ray imaging components including X-ray tubes, digital detectors, linear accelerators and other image processing solutions, which are key components of X-ray imaging systems.

Our components are used in medical imaging as well as in industrial and security imaging applications.

Global original equipment manufacturers (“OEM”) incorporate our X-ray imaging components in their systems to detect, diagnose, protect and inspect.

We have not assumed any obligation to, and you should not expect us to, update or revise those statements because of new information, future events or otherwise.

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 mission critical components of a variety of X-ray based diagnostic imaging equipment.

These products are used in medical imaging as well as in industrial and security imaging applications such as general X-ray, computed tomography (“CT”), C-arms, angiography, fluoroscopy, mammography, and dental.

In addition, our components are also used in security and quality inspection systems, as well as for analysis and measurement applications in industrial manufacturing applications.

Global original equipment manufacturers (“OEMs”) incorporate our X-ray imaging components in their systems to detect, diagnose, protect and inspect.

Varex has approximately 2,000 full-time equivalents employees, located at manufacturing and service center sites in North America, Europe, and Asia.

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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.

We continue to invest in research and development and employ over 500 engineers.

Combining this focus on innovation and product performance with strong long-term customer relationships allows us to partner with our customers to bring industry-leading products to the X-ray imaging market.

We continue to work to improve the life and quality of our imaging components and leverage our scale as the largest X-ray imaging component supplier to provide cost-effective solutions for our customers.

Demand for our products can also be impacted by geo-political factors, including the COVID-19 pandemic as well as tariffs on key imported materials used in manufacturing our products and on X-ray imaging products we sell to customers outside the United States.

Trade conflicts between the United States and China has negatively impacted our business and are expected to continue.

We continue to invest in research and development and employ approximately 500 individuals in product development.

Combining this focus on innovation and product performance with strong long-term customer relationships allows us to collaborate with our customers to bring industry-leading products to the X-ray imaging market.

We continue to work to improve the life and quality of our imaging components and leverage our scale as one of the largest independent X-ray imaging component suppliers to provide cost-effective solutions for our customers.

Impact of COVID-19

The unprecedented nature of the COVID-19 pandemic and its impact on the global economy has created a disruption to Varex’s business which includes increased uncertainty in demand for certain products for medical and industrial applications, as well as increased variability in our supply chain and manufacturing productivity.

The economic downturn triggered by COVID-19 has led

to significantly lower demand from our customers and delays in equipment installations.

In conjunction with this reduced forecast and uncertainty beyond the forecast horizon, we evaluated our product offering and decided to discontinue certain low margin, low demand products.

As a result, we took approximately $16 million in reserves related to the write-down of the value of all associated inventory and any other associated assets.

The COVID-19 pandemic has had a significant effect on hospitals, clinics and outpatient imaging centers as they have encountered declines in surgeries and other elective procedures.

Subsequently, they have reduced their capital purchases of imaging equipment from OEM’s which has led to lower demand for x-ray imaging components.

Additionally, equipment installations were delayed, due to reduced access to healthcare institutions.

Partially offsetting this has been increased demand for imaging equipment used to diagnose respiratory diseases, such as radiographic x-ray imaging systems and CT imaging systems.

We expect uncertainty related to the COVID-19 pandemic to continue for at least the remainder of the current calendar year.

The Company expects uncertainty in demand to continue for at least the remainder of the current calendar year.

While we have implemented safeguards and procedures to counter the impact of the COVID-19 pandemic, the full extent to which the COVID-19 pandemic has 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 estimated with certainty, including the further mitigation efforts taken to contain it or treat its impact and the economic impact on local, regional, national and international markets.

The unprecedented nature of the COVID-19 pandemic and its impact on the global economy has created a disruption to our business that includes increased uncertainty in demand for certain medical and industrial products, as well as increased variability in

our supply chain and manufacturing productivity.

The economic downturn triggered by COVID-19 has led to significantly lower demand from our customers and delays in equipment installations.

The COVID-19 pandemic has had a significant effect on hospitals, clinics and outpatient imaging centers as they have encountered declines in surgeries and other non-emergency procedures and have reallocated resources to combat the ongoing pandemic.

As a result of the ongoing uncertainty surrounding COVID-19 and a requirement to focus on immediate needs, many hospitals, clinics and outpatient imaging centers have reduced their capital purchases of imaging equipment from OEMs which has led to lower demand for X-ray imaging components.

In addition, reduced usage of certain X-ray equipment has resulted in less demand for replacement components that wear-out with use.

Additionally, equipment installations were delayed, due in part to efforts to limit non-essential visits to healthcare facilities.

Partially offsetting the general demand for X-ray imaging components has been increased demand for CT and certain radiographic diagnostic imaging equipment used to screen for or assist in the treatment of respiratory diseases (such as COVID-19).

While healthcare systems and economies around the world have begun to reopen, customer demand has not returned to pre-pandemic levels, and the adverse effects of COVID-19 on our financial statements and results of operations have been significant.

While we believe that the fundamentals driving long-term demand in both our Medical and Industrial segments remain intact, we believe that in the near-term, reduced demand in our Industrial segment and for certain higher-end medical products will continue to negatively impact our business potential and our results of operations.

While our manufacturing sites are currently up and running, COVID-19 and associated economic disruptions have had an adverse impact on our manufacturing capacity, supply chains and distribution systems, including as a result of impacts associated with preventive and precautionary measures that we, other businesses and governments are taking.

Supply chain logistics have also become more challenging and while we have had success in localizing our supply chain through our “local-for-local” initiative, supply chain logistics could remain challenging.

The actions taken to combat COVID-19 have had, and we believe will continue to have, a negative impact on our operating results, cash flows and financial condition.

We expect uncertainty related to the COVID-19 pandemic to continue into the middle of calendar year 2021.

While we have implemented safeguards and procedures and taken other measures to counter the impact of the COVID-19 pandemic, the full extent to which the COVID-19 pandemic has 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 as may be required by federal, state, or local authorities or that we determine are in the best interests of our employees, customers, suppliers, and stockholders.

Subsequent Measurement of Goodwill

Goodwill is not amortized but is tested annually, or more often if impairment indicators are present, for impairment at a reporting unit level, based on a comparison of the fair value of the reporting unit with its carrying amount.

Goodwill is tested for impairment via a one-step process by comparing the fair value of goodwill with its carrying amount.

We recognize an impairment for the amount by which the carrying amount exceeds the fair value.

We generally use both an income approach utilizing the discounted cash flow method ("DCF") and a market approach utilizing the public company market multiple method, when testing for impairment.

In the third quarter of 2020, changes in facts and circumstances and general market declines from COVID-19 resulted in reduced operating results.

We considered these circumstances and the potential long-term impact on cash flows associated with our reporting units and determined that an indicator of possible impairment existed within our Medical and Industrial reporting units.

Accordingly, we performed a quantitative impairment analysis to determine the fair values of those reporting units.

We used both an income approach utilizing the discounted cash flow method ("DCF") and a market approach utilizing the public company market multiple method.

We developed multiple forecasted future cash flow scenarios for the reporting units with varied recovery timing and sales impact assumptions.

Based on the output of the analysis, we determined that the fair values of both the Medical and Industrial reporting units exceeded their carrying amounts.

Accordingly, no impairment charges were required as of July 3, 2020.

However, an impairment charge was required for the Company's in-process R&D.

The Company's Industrial reporting unit's fair value exceeded its carrying value by more than 20 % and the Company's Medical reporting unit's fair value exceeded its carrying value by more than 30 %.

The carrying amount of goodwill for the Medical and Industrial reporting units was $ 173.0 million and $ 117.8 million, respectively.

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, growth rates, 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 growth rates and 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.

Refer to Note 10, Goodwill and Intangible Assets for more information regarding goodwill.

Operating Segments and Products

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The segments align our products and service offerings with customer use in medical and industrial markets and are consistent with how the CODM evaluates the business for the allocation of resources.

The CODM allocates resources to and evaluates the financial performance of each operating segment primarily based on revenues and gross margin.

In our Medical business segment, we design, manufacture, sell and service X-ray imaging components for use in a range of radiographic or fluoroscopic imaging applications including, computed tomography (“CT”), mammography, oncology, cardiac, surgery, dental, and computer-aided detection.

We provide a broad range of X-ray imaging components for Medical customers, including X-ray tubes, digital detectors, high voltage connectors, image-processing software and workstations, computer-aided diagnostic software, collimators, automatic exposure control devices, generators, heat exchangers, ionization chambers and buckys.

A significant portion of our revenues come from the sales of high-end X-ray tubes used in CT imaging and high-end dynamic digital detectors used in fluoroscopic and 3D dental imaging applications.

These upper-tier imaging components are characterized by increased levels of technological complexity, engineering and intellectual property that typically allow these products to have a higher sales price and gross margin.

The digital detector market has matured from initial product introductions that were made over 15 years ago.

For the past few years, we have experienced price erosion for these products, predominantly in the highly-competitive market for radiographic detectors.

We anticipate this trend will continue in the foreseeable future.

Our X-ray imaging components are primarily sold to OEM customers that incorporate our products into their X-ray imaging systems for a variety of medical modalities and industrial applications.

To a much lesser extent, we also sell our X-ray imaging components to independent service companies, distributors and directly to end-users for replacement purposes.

The COVID-19 pandemic has had a significant effect on hospitals, clinics and outpatient imaging centers as they have encountered declines in surgeries and other elective procedures.

Subsequently, they have reduced their capital purchases of imaging equipment from OEM’s which has led to lower demand for x-ray imaging components.

Additionally, equipment installations were delayed, due to reduced access to healthcare institutions.

Partially offsetting this has been increased demand for imaging equipment used to diagnose respiratory diseases, such as radiographic x-ray imaging systems and CT imaging systems.

The Company expects uncertainty in demand to continue for at least the remainder of the current calendar year.

In China, the government is broadening the availability of healthcare services throughout the country.

As a result, the number of diagnostic X-ray imaging systems, including CT, has grown significantly.

We are developing CT tubes and related subsystems for Chinese OEMs as they introduce new CT imaging systems in China.

Over the long-term, we anticipate that China-based revenues will increase as a percentage of our revenues.

To help mitigate the impact of trade war conflicts between the United States and China, we have implemented changes to secure more non-China sources of supply of parts and materials used to manufacture our X-ray imaging products.

We continue to expand manufacturing capabilities at our facilities in China, Germany and the Philippines.

In our Industrial business segment, we design, manufacture, sell and service X-ray imaging products for use in a number of markets, including security applications, such as cargo screening at ports and borders and baggage screening at airports, as well as nondestructive testing and inspection applications used in a number of other markets.

The CODM allocates resources to and evaluates the financial performance of each operating segment primarily based on revenues and gross profit.

In our Medical segment, we design, develop, manufacture, sell and service X-ray imaging components, including X-ray tubes, digital detectors, high voltage connectors, image-processing software and workstations, 3D reconstruction software, computer-aided diagnostic software, collimators, automatic exposure control devices, generators, heat exchangers, ionization chambers and bucky systems.

These components are used in a range of medical imaging applications, including CT, mammography, oncology, cardiac, surgery, dental, and for other diagnostic radiography uses.

Our X-ray imaging components are sold primarily to OEM customers.

These OEM customers then design-in our products into their X-ray imaging systems for a variety of medical modalities.

A substantial majority of medical X-ray imaging OEMs globally are our customers, and many of these have been customers for over 25 years.

We believe one of the reasons for customer loyalty is that our hardware and software products are tightly integrated with our customers’ systems.

We work very closely with our customers to create custom built components for their systems based on technology platforms that we have developed.

Because our products are often customized for our customers’ specific equipment, it can be costly and complex for our customers to switch to another provider.

Once our components are designed into our customer’s equipment, our customers will typically continue to use us to supply any replacement components and for service and support for that equipment.

Some of our products are also included in product registrations for our customer’s equipment that require regulatory approval to change.

In addition to sales directly to OEM customers, we also sell our products to independent service companies and distributors and directly to end-users for replacement purposes.

In China, the government is broadening the availability of healthcare services.

As a result, the number of diagnostic X-ray imaging systems, including CT imaging systems, has grown significantly.

We are developing CT X-ray tubes and related subsystems for Chinese OEMs as they introduce new systems in China.

We presently have multi-year pricing agreements for CT tubes with 8 medical X-ray imaging OEMs in China.

Over the long-term, our objective is to become the partner of choice both for OEMs and in the replacement market as CT systems become more widely adopted throughout the Chinese market.

In recent years our business in China has been impacted by the trade war with the United States in two principal ways:

(1) imports of raw materials from China have become more expensive and (2) importing finished U.S.

manufactured products into China has also become more difficult and more expensive.

To mitigate the impact of tariffs on materials imported from China, we have implemented changes to secure more non-China sources of materials used to manufacture our X-ray imaging products.

With respect to imports into China, the additional tariffs imposed by the Chinese government led to a decrease in sales of radiographic detectors manufactured outside of China.

To help address these issues, as well as to be closer to our global customer base, we continue to expand manufacturing capabilities at our facilities in China, Germany and the Philippines and also implemented local sourcing strategies to lower our costs and offer local content.

This local-for-local strategy has been well received by both our local customers as well as global OEMs, and acts as a natural hedge against trade wars and other potential supply chain disruptions.

In our Industrial segment, we design, develop, manufacture, sell and service X-ray imaging products for use in a number of markets, including security applications for cargo screening at ports and borders and also baggage screening at airports, and nondestructive testing and inspection applications used in a number of other vertical markets.

Our industrial products include Linatron® X-ray linear accelerators, X-ray tubes, digital detectors and high voltage connectors.

In addition, we provide proprietary image-processing and detection software designed to work with these other Varex products to provide package solutions to our Industrial customers.

In addition, we license proprietary image-processing and detection software designed to work with other Varex products to provide packaged sub-assembly solutions to our industrial customers.

Our Industrial business benefits from the research and development investment as well as manufacturing economies of scale on the Medical side of our business, as we continue to find new applications for our technology.

Along with more favorable pricing dynamics, this allows us to generally achieve higher gross profit for industrial products relative to our Medical business.

In addition, our Industrial business benefits from our long-term service agreements for our Linatron® products.

The security market primarily consists of airport security for carry-on baggage, checked baggage and palletized cargo, as well as cargo security for the screening of trucks, trains and cargo containers at ports and borders.

The end customers for border protection systems are typically government agencies, many of which are in oil-based economies and war zones where there has been significant year over year variation in buying patterns.

The non-destructive testing market utilizes X-ray imaging to scan items for inspection of manufacturing defects and product integrity in a wide range of industries including the aerospace, automotive, oil and gas, food packaging, metal castings and 3D printing industries.

We provide X-ray sources, digital detectors, high voltage connectors and image processing software to OEM customers, system integrators and manufacturers.

Non-destructive testing and inspection verticals utilize X-ray imaging to scan items for inspection of manufacturing defects and product integrity in a wide range of industries including the aerospace, automotive, electronics, oil and gas, food packaging, metal castings and 3D printing industries.

In addition, new applications for X-ray sources are being developed, such as sterilization of food and its packaging.

The economic downturn triggered by the COVID-19 pandemic has reduced the demand for x-ray imaging equipment utilized in the non-destructive testing market as manufacturers have focused on cash preservation which includes reduced spending for capital equipment.

We provide X-ray sources, digital detectors, high voltage connectors and image processing software to OEM customers, system integrators and manufacturers in a variety of these verticals.

We believe that the non-destructive testing market represents a significant growth opportunity for our business and we are actively pursuing new potential applications for our products.

The economic downturn triggered by the COVID-19 pandemic has reduced the demand for X-ray imaging equipment utilized in the non-destructive testing market as manufacturers have focused on cash preservation and have reduced spending for capital equipment.

Additionally, the unprecedented decrease in passenger air traffic has led to decrease in demand in the security market.

The Company expects uncertainty in demand to continue for at least the remainder of the current calendar year.

Critical Accounting Policies and Estimates

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We periodically review our accounting policies, estimates and assumptions and make adjustments when facts and circumstances dictate.

Refer to our Annual Report on Form 10-K for the fiscal year ended September 27, 2019 filed with the SEC on December 20, 2019 and Note 1 “Summary of Significant Accounting Policies” of the notes to the condensed consolidated financial statements of this report for further details.

Our critical accounting policies that are affected by accounting estimates include revenue recognition, impairment of investments, assessment of recoverability of goodwill and intangible assets, valuation of derivative instruments, valuation of warranty obligations, and taxes on earnings.

Refer to our Annual Report on Form 10-K for the fiscal year ended October 2, 2020 filed with the SEC on November 30, 2020 and Note 1 “Summary of Significant Accounting Policies” of the notes to the condensed consolidated financial statements of this report for further details.

Our critical accounting policies that are affected by accounting estimates include valuation

of inventories, assessment of recoverability of goodwill and intangible assets, and taxes on earnings.

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.

There have been no material changes to our critical accounting policies, estimates and assumptions or the judgments affecting the application of those estimates and assumptions since the filing of our Annual Report on Form 10-K for year ended September 27, 2019, except for the adoption of Accounting Standards Update ("ASU") 2016-02, Leases ("Topic 842"), referred to as ASC 842, effective September 28, 2019, and the adoptions of ASU 2017-04, Intan gibles - Goodwill and Other, which simplifies the test for goodwill impairment, effective April 4, 2020.

There have been no changes to our critical accounting policies, estimates and assumptions or the judgments affecting the application of those estimates and assumptions since the filing of our Annual Report on Form 10-K for year ended October 2, 2020.

Our fiscal year is a 52 or 53-week period ending on the Friday nearest September 30.

Fiscal year 2021 is the 52-week period ending October 1, 2021.

Fiscal year 2019 was a 52-week period that ended on September 27, 2019.

The fiscal quarters ended July 3, 2020 and June 28, 2019 were both 13-week periods.

Discussion of Results of Operations for the Three Months Ended July 3, 2020 Compared to the Three Months Ended June 28, 2019

Fiscal year 2020 was the 53-week period that ended on October 2, 2020.

The fiscal quarters ended January 1, 2021 and January 3, 2020 were 13-week and 14-week periods, respectively.

Discussion of Results of Operations for the Three Months Ended January 1, 2021 Compared to the Three Months Ended January 3, 2020

Revenues, net

Three Months Ended

(In millions) July 3, 2020 June 28, 2019 $ Change % Change

(In millions) January 1, 2021 January 3, 2020 $ Change % Change

$ 139.2 $ 155.6 $ (16.4) (10.5) %

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Industrial as a percentage of total revenues 21.4 % 22.2 %

Medical revenues decreased by $14.0 million primarily due to decreased sales of digital detectors for dynamic imaging applications, partially offset by increased sales of CT X-ray tubes and digital detectors for radiographic X-ray imaging applications.

Industrial revenues decreased $11.5 million primarily due to decreased sales of X-ray tubes, digital detectors and linear accelerators for security and non-destructive inspection applications.

Medical revenues decreased by $16.4 million primarily due to decreased sales of digital detectors for dynamic imaging applications and the comparative prior year period including an additional week.

This was partially offset by increased sales of CT X-ray tubes and digital detectors for radiographic X-ray imaging applications.

Industrial revenues decreased $6.6 million primarily due to decreased sales of X-ray tubes, digital detectors and linear accelerators for security and non-destructive inspection applications and the comparative prior year period including an additional week.

Three Months Ended

(In millions) July 3, 2020 June 28, 2019 $ Change % Change

(In millions) January 1, 2021 January 3, 2020 $ Change % Change

$ 44.1 $ 43.8 $ 0.3 0.7 %

13.1 17.3 (4.2) (24.3) %

Total gross margin $ 26.3 $ 60.7 $ (34.4) (56.7) %

Total gross profit $ 57.2 $ 61.1 $ (3.9) (6.4) %

Medical gross margin 31.7 % 28.1 %

13.1 % 29.2 %

Industrial gross margin 34.6 % 38.9 %

Total gross margin 32.3 % 30.5 %

The decrease in total gross margin percentage was due to the decrease in both medical and industrial gross margin percentages.

The decrease in medical gross margin percentage was primarily due to an unfavorable mix of lower margin products and an approximate $13 million charge for the write-down of inventory associated with discontinued products and restructuring activity.

The industrial gross margin percentage decreased due to an unfavorable mix of lower margin products and an approximate $3 million charge for the write-down of inventory associated with discontinued products and restructuring activity.

The decrease in total gross profit was due primarily to the decreases in the gross profit of our Industrial Segment.

The Industrial Segment gross profit was down as a result of decreased sales of X-ray tubes, digital detectors, and linear accelerators for security and non-destructive inspection applications.

The increase in medical gross margin was primarily due to the impacts of cost reduction measures taken by management in previous quarters and a favorable product mix in medical detectors.

Operating Expenses

Three Months Ended

(In millions) July 3, 2020 June 28, 2019 $ Change

(In millions) January 1, 2021 January 3, 2020 $ Change

Research and development $ 16.7 $ 21.7 $ (5.0) (23.0) %

As a percentage of total revenues

11.1 % 10.6 %

Selling, general and administrative $ 34.4 $ 34.8 $ (0.4) (1.1) %

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19.4 % 17.4 %

Impairment of intangible assets $ 2.7 $ 4.0 $ (1.3) (32.5) %

As a percentage of total revenues

Operating expenses

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We are committed to investing in the business to support long-term growth and believe long-term research and development expenses of approximately 8% to 10% of annual revenues is the appropriate range that will allow us to innovate and bring new products to market for our global OEM customers.

On a dollar basis, research and development costs decreased for the third quarter, but because revenue declined, increased to 11.1% of revenues for the third quarter of 2020.

Research and development costs decreased to 9.4% of revenues for the first quarter of 2021 primarily due to cost actions and improved material cost management.

Selling, General and Administrative

Selling, general and administrative expenses for the third quarter of 2020 increased to 18.3% of total revenues primarily due to lower revenues during the three months ended July 3, 2020.

Selling, general and administrative expenses for the first quarter of 2021 decreased slightly in terms of dollars, but increased to 19.4% of total revenues primarily due to a lower sales base and higher audit fees during the three months ended January 1, 2021.

Interest and Other Expense, Net

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Three Months Ended

(In millions) July 3, 2020 June 28, 2019 $ Change

Interest income

Interest expense

(6.9) (5.1) (1.8)

Other expense, net

(6.1) (0.1) (6.0)

Interest and other expense, net

$ (13.0) $ (5.2) $ (7.8)

Interest and other expense, net increased during the three months ended July 3, 2020.

Interest expense increased due to the interest related to our Convertible Notes issued during June 2020 and an increase in our interest rate margin during the three months ended July 3, 2020.

Other expense, net increased during the third quarter of 2020, due to the impairment of certain investments in privately-held companies, an increase in the fair value of the deferred consideration related to the Direct Conversion acquisition and a decrease in our income from investments in privately-held companies.

Taxes on (Loss) Earnings

For the three months ended July 3, 2020, we recognized an income tax benefit of $11.6 million on a $39.8 million pre-tax loss.

For the three months ended June 28, 2019, we recognized an income tax benefit of $0.7 million on $0.6 million of pre-tax loss.

Discussion of Results of Operations for the Nine Months Ended July 3, 2020 Compared to the Nine Months Ended June 28, 2019

Nine Months Ended

(In millions) July 3, 2020 June 28, 2019 $ Change % Change

$ 448.6 $ 444.4 $ 4.2 0.9 %

119.7 133.8 (14.1) (10.5) %

Total revenues $ 568.3 $ 578.2 $ (9.9) (1.7) %

Medical as a percentage of total revenues 78.9 % 76.9 %

Industrial as a percentage of total revenues 21.1 % 23.1 %

Medical revenues increased by $4.2 million primarily due to increased sales of CT X-ray tubes and digital detectors for dental applications, partially offset by decreased sales of radiographic digital detectors.

Industrial revenues decreased $14.1 million due to decreased sales of linear accelerators for cargo inspection and other non-destructive inspection applications.

Nine Months Ended

(In millions) July 3, 2020 June 28, 2019 $ Change % Change

$ 105.2 $ 135.4 $ (30.2) (22.3) %

39.8 49.7 (9.9) (19.9) %

Total gross margin $ 145.0 $ 185.1 $ (40.1) (21.7) %

Medical gross margin %

23.5 % 30.5 %

Industrial gross margin % 33.2 % 37.1 %

Total gross margin % 25.5 % 32.0 %

The decrease in total gross margin percentage was due to the decrease in both medical and industrial gross margin percentage.

The decrease in medical gross margin percentage was primarily due to an unfavorable mix of lower margin products, additional reserves for the settlement of a German customs audit, higher warranty and slow-moving inventory reserves, the write-down of inventory associated with discontinued products, and customer price decreases for digital detectors.

The industrial gross margin percentage decreased due to an unfavorable mix of lower margin products and the write-down of inventory associated with discontinued products..

Operating Expenses

Nine Months Ended

(In millions) July 3, 2020 June 28, 2019 $ Change

Research and development

$ 61.6 $ 58.5 $ 3.1 5.3 %

As a percentage of total revenues

10.8 % 10.1 %

Selling, general and administrative

$ 101.5 $ 92.3 $ 9.2 10.0 %

As a percentage of total revenues

17.9 % 16.0 %

Impairment of intangible assets $ 2.7 $ 4.8 $ (2.1) (43.8) %

As a percentage of total revenues

Operating expenses

$ 163.1 $ 155.6 $ 7.5 4.8 %

As a percentage of total revenues

28.7 % 26.9 %

Research and Development

Research and development costs increased to 10.8% of revenues due to the addition of Direct Conversion for the nine months ended July 3, 2020.

Selling, General and Administrative

Selling, general and administrative expenses for the nine months ended July 3, 2020, increased to 17.9% primarily due to higher audit and consulting fees, an extra week of expenses in the period and the addition of Direct Conversion.

Interest and Other Income (Expense), Net

The following table summarizes the Company’s interest and other income (expense), net:

Nine Months Ended

(In millions) July 3, 2020 June 28, 2019 $ Change

Interest income

$ 0.1 $ 0.1 $ —

(In millions) January 1, 2021 January 3, 2020 $ Change

Interest expense

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$ (10.8) $ (5.8) $ (5.0)

Interest and other expense, net increased during the nine months ended July 3, 2020.

Interest expense increased due to the interest related to our Convertible Notes issued during June 2020.

Other expense, net increased during the nine months ended July 3, 2020 due to the impairment of certain investments in privately-held companies and a decrease in the fair value of the deferred consideration related to the Direct Conversion acquisition.

Interest and other expense, net increased during the three months ended January 1, 2021 as compared to the prior year period, primarily due to higher interest expense.

Interest expense increased primarily due to increased interest expense related the issuance of our Convertible Notes in June 2020 and the issuance of our Senior Secured Note in September 2020.

Other expense, net was basically flat for the three months ended January 1, 2021 as compared to the three months ended January 3, 2020.

Taxes on (Loss) Earnings

For the nine months ended July 3, 2020, we recognized an income tax benefit of $(10.9) million on $42.1 million of pre-tax loss before tax.

For the nine months ended June 28, 2019, the Company recognized income tax expense of $3.7 million on $11.3 million of pre-tax income.

For the three months ended January 1, 2021, we recognized income tax expense of $1.6 million on a $4.7 million pre-tax loss.

We are unable to recognize a tax benefit for pre-tax book losses in the U.S.

and certain foreign jurisdictions but have recognized tax expense for profitable foreign jurisdictions.

For the three months ended January 3, 2020, we recognized income tax expense of zero on $1.2 million of pre-tax loss.

Our tax expense for the three months ended January 1, 2021 increased, compared to the prior year, primarily due to valuation allowance positions in the U.S.

on disallowed interest expense deductions and losses in the U.S.

and certain foreign jurisdictions for which no benefit can be recorded.

Liquidity and Capital Resources

We assess our liquidity in terms of our ability to generate cash to fund our operating and investing activities.

As part of a series of measures to better enable the Company to weather the extraordinary business challenges associated with the COVID-19 global pandemic, we have taken additional measures to manage our cash.

These measures include temporary reductions to employee compensation and matching retirement contributions, as well as furloughs, mandatory unpaid leave for U.S.

employees that are not directly related to the production of our products and a reduction of the Company’s workforce by approximately 94 employees.

continue to evaluate additional cash preserving actions and other sources of capital as needed to secure liquidity in a rapidly changing environment.

The Company’s Credit Agreement, as defined in Note 11, Borrowings, contains financial covenants, including certain leverage ratio covenants.

The Company was in compliance with all financial covenants as of July 3, 2020.

However, the adverse effects of the COVID-19 pandemic on the Company’s financial condition and results of operations are expected to be more persistent and have been more severe than previously estimated in the prior quarter forecasted financial results.

Specifically, in conjunction with analyzing the results for the Company’s third quarter, the Company now believes that reduced demand in the Company’s industrial segment and for certain higher end medical products will continue to negatively impact revenues, gross margin and the other items used to calculate the Company’s financial covenants contained in its Credit Agreement.

Based on the Company’s current forecasts, it is probable that the Company will be in violation of certain leverage ratio covenants contained in its Credit Agreement within the twelve-month period following the issuance of these financial statements, including as early as the end of the Company's fiscal year end 2020.

Failure to comply with the covenants, if not amended or waived, would result in an event of default under the Credit Agreement and the acceleration of the outstanding balance of the loans thereunder.

If an event of default under the Credit Agreement occurs, then pursuant to cross default and/or cross acceleration clauses, substantially all of the Company’s other outstanding debt and derivative contract payables would become due, and all debt and derivative contracts could be terminated, which would have a material adverse impact to the Company’s operations and liquidity as the Company currently does not have the financial resources to satisfy such obligations if they were to become due and payable.

These events and conditions raise substantial doubt about the Company’s ability to continue as a going concern within the twelve-month period following the issuance of these financial statements.

The Company is actively pursuing various options to prevent an event of default from occurring under the Credit Agreement.

The Company is implementing actions to improve its financial results and other items used to calculate the financial covenants,, such as accelerating the closure of its Santa Clara facility, the previously announced reduction in force, austerity programs related to outside services, and other appropriate actions.

The Company is also taking actions to improve cash flow such as working capital reductions and reduced spending for property, plant and equipment, as well as pursuing potential additional fundraising to modify, supplement, or replace its Credit Agreement.

While the Company has and continues to take actions to mitigate the risk of an event of default under the Credit Agreement, there is no assurance that it will be successful in doing so.

The Company’s unaudited condensed consolidated financial statements have been prepared on a going concern basis and do not reflect any adjustments that might result if the Company is unable to continue as a going concern.

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 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, and are sufficient to meet our

anticipated operating cash need for at least the next 12 months.

The maximum availability under our ABL Facility was $100.0 million as of January 1, 2021, however, the borrowing base under the ABL Facility fluctuates from month-to-month depending on the amount of eligible accounts receivable and inventory.

See Part II, Item 1A.

“Risk Factors” for a further discussion.

At January 1, 2021 we had $457.5 million in long-term debt and $2.6 million of current maturities of long-term debt, net of deferred issuance costs of $53.7 million.

Borrowings, in the accompanying notes to our condensed consolidated financial statements for more information regarding our indebtedness.

Cash and Cash Equivalents

The following table summarizes our cash and cash equivalents:

(In millions) July 3, 2020 September 27, 2019 $ Change

(In millions) January 1, 2021 October 2, 2020 $ Change

Cash and cash equivalents

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The following table summarizes the changes in our debt outstanding:

(In millions)

July 3, 2020 September 27, 2019 $ Change

Current portion of Term Facility

$ 26.8 $ 29.4 $ (2.6)

Current portion of other long-term debt 0.8 1.3 (0.5)

Revolving Credit Facility

— 59.0 (59.0)

Long-term portion of Term Facility

238.7 308.6 (69.9)

Convertible Notes 200.0 — 200.0

Long-term portion of other debt

Total debt outstanding, gross

474.5 400.8 73.7

Debt issuance costs - Credit Agreement

January 1, 2021 October 2, 2020

(In millions, except for percentages) Amount Amount $ Change

Current maturities of long-term debt

Other debt 2.6 2.5 0.1

Total current maturities of long-term debt $ 2.6 $ 2.5 $ 0.1

Non-current maturities of long-term debt:

Asset-Based Loan — — —

Convertible Senior Unsecured Notes 200.0 200.0 —

Senior Secured Notes 300.0 300.0 —

Other debt 11.2 8.8 2.4

Total non-current maturities of long-term debt:

$ 511.2 $ 508.8 $ 2.4

Unamortized issuance costs and debt discounts

Unamortized discount - Convertible Notes (43.6) (45.5) 1.9

Unamortized issuance costs - Convertible Notes (4.7) (4.9) 0.2

Unamortized issuance costs - Senior Secured Notes (5.4) (5.6) 0.2

Total $ (53.7) $ (56.0) $ 2.3

Total debt outstanding, net $ 460.1 $ 455.3 $ 4.8

$ 417.1 $ 395.1 $ 22.0

Nine Months Ended

(In millions) July 3, 2020 June 28, 2019

Three Months Ended

(In millions) January 1, 2021 January 3, 2020

Net cash flow provided by (used in):

Operating activities

$ 25.0 $ 49.0

Investing activities

(23.2) (86.4)

Financing activities

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Net increase in cash and cash equivalents and restricted cash

$ 57.5 $ (23.4)

Net Cash Provided by Operating Activities.

Cash from operating activities consists primarily of the net (loss) earnings adjusted for certain non-cash items, including share-based compensation, depreciation, amortization of intangible assets, deferred income taxes, income from equity investments and the effect of changes in operating assets and liabilities.

For the nine months ended July 3, 2020, compared to the nine months ended June 28, 2019, cash provided by operating activities were as follows:

• Net (loss) earnings were $(31.2) million compared to $7.6 million

Cash from operating activities consists primarily of the net loss adjusted for certain non-cash items, including share-based compensation, depreciation, amortization of intangible assets, deferred income taxes, income from equity investments and the effect of changes in operating assets and liabilities.

For the three months ended January 1, 2021, compared to the three months ended January 3, 2020, cash provided by operating activities were as follows:

• Net losses were $6.3 million compared to $1.2 million

• Non-cash adjustments to net earnings of $17.9 million compared to $13.3 million

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◦ Accounts receivable decreased by $2.2 million compared to $18.5 million,

◦ Inventories increased by $50.1 million compared to $26.2 million,

◦ Prepaid expenses and other assets decreased by $7.7 million compared to an increase of $4.7 million,

◦ Accounts payable increased by $21.7 million compared to a decrease of $4.3 million, and

◦ Inventories decreased by $2.5 million compared to an increase of $21.1 million,

◦ Prepaid expenses and other assets increased by $2.0 million compared to a decrease of $3.7 million,

◦ Accounts payable decreased by $4.2 million compared to a increase of $15.4 million, and

◦ Accrued liabilities and other current and long-term operating liabilities decreased by $2.7 million compared to $4.8 million.

Net Cash Used in Investing Activities.

Net cash used in investing activities was $23.2 million and $86.4 million for the nine months ended July 3, 2020 and June 28, 2019, respectively.

The decrease in cash used in investing activities was primarily due to a business acquisition during the nine months ended June 28, 2019.

Net Cash Provided by Financing Activities.

Financing activities for the nine months ended July 3, 2020 consisted of the issuance of $200.0 million in aggregate principal amount of 4.00% unsecured convertible senior notes due 2025 (“Convertible Notes”).

The net proceeds from the issuance of the Convertible Notes, after deducting transaction fees, were approximately $193.1 million.

In connection with offering the Convertible Notes, we separately entered into privately negotiated convertible note hedge transactions (collectively, the “Hedge Transactions”).

The Hedge Transactions cover, subject to customary anti-dilution adjustments, the number of shares of our common stock that initially underlie the Convertible Notes.

We also entered into warrant transactions (collectively, the “Warrant Transactions” and, together with the Hedge Transactions, the “Call Spread Transactions”), whereby we sold warrants at a higher strike price relating to the same number of shares of our common stock that initially underlie the Convertible Notes, subject to customary anti-dilution adjustments.

We used $11.2 million of the net proceeds from the issuance of the Convertible Notes to pay the cost of the Call Spread Transactions.

Additionally, during the nine months ended July 3, 2020, we had borrowings under our credit agreement of $91.7 million and repayments of borrowings of $218.0 million.

Financing activities for the nine months ended June 28, 2019 consisted of borrowings under our credit agreement of $79.0 million, and repayments of borrowings of $65.7 million.

Net cash used in investing activities was $4.4 million and $10.6 million for the three months ended January 1, 2021 and January 3, 2020, respectively.

The decrease in cash used in investing activities was primarily due to higher capital spending during the three months ended January 3, 2020.

Net Cash Provided by (Used in) Financing Activities.

Financing activities for the three months ended January 1, 2021 provided $2.2 million while during the three months ended January 3, 2020, we used $12.0 million primarily for repayments of borrowings of our legacy credit agreement.

Days Sales Outstanding

Trade accounts receivable days sales outstanding (“DSO”) was 58 days at July 3, 2020 and 63 days at September 27, 2019.

Trade accounts receivable days sales outstanding (“DSO”) was 62 days at January 1, 2021 and 66 days at October 2, 2020.

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.

3 unchanged sentences

In January 2021, the fixed cost commitment was determined and approved by the dpiX board of directors to be $11.6 million for calendar year 2021.

As of July 3, 2020, the Company had $6.4 million fixed cost commitments related to this agreement remaining for calendar

The amended agreement will continue unless the ownership structure of dpiX changes (as defined in the amended agreement).

In October 2015, 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.

As of July 3, 2020, noncontrolling shareholders together held approximately 0.5 million shares of MeVis, representing 26.5% of the outstanding shares.

See Note 12, “Redeemable Noncontrolling Interests” of the notes to the condensed consolidated financial statements for more information.

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 an annual recurring net compensation of €0.95 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 January 1, 2021, noncontrolling shareholders together held approximately 0.5 million shares of MeVis, representing 26.3% of the outstanding shares.

During the third quarter of fiscal year 2020, we 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 our products.

As of January 1, 2021, there has been no transfer of control of the underlying equipment.

This acquisition is expected to be completed during the 2021 fiscal year and the total consideration to be paid by us for the acquired assets is expected to be ¥1,084.7 million or approximately $10.5 million.

Contingencies

From time to time, we are a party to or otherwise involved in legal proceedings, claims and government inspections or investigations, customs and duties audits and other loss contingency matters, both inside and outside the United States, arising in the ordinary course of our business or otherwise.

Such matters are subject to many uncertainties and outcomes are not predictable with assurance.

From time to time, the Company is a party to or otherwise involved in legal proceedings, claims and government inspections or investigations, customs and duty 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.

The Company did not have any material contingent liabilities as of January 1, 2021 and October 2, 2020.

Legal expenses are expensed as incurred.

Off-Balance Sheet Arrangements

In conjunction with the sale of our products in the ordinary course of business, we provide standard indemnification of business partners and customers for losses suffered or incurred for property damages, death and injury and for patent, copyright or any other intellectual property infringement claims by any third parties with respect to our products.

In conjunction with the sale of our products in the ordinary course of business, and consistent with industry practice, we provide standard indemnification of business partners and customers for losses suffered or incurred for property damages, death and injury and for patent, copyright or any other intellectual property infringement claims by any third parties with respect to our products.

The terms of these indemnification arrangements are generally perpetual.

Except for losses related to property damages, the maximum potential amount of future payments we could be required to make under these arrangements is unlimited.

As of July 3, 2020, we have not incurred any material costs to defend lawsuits or settle claims related to these indemnification arrangements.

As of January 1, 2021, we have not incurred any material costs to defend lawsuits or settle claims related to these indemnification arrangements.

As a result, we believe the estimated fair value of these arrangements is minimal.

We have indemnification obligations to our directors and officers and certain of our employees that serve as officers or directors of our foreign subsidiaries that may require us to indemnify our directors and officers and those certain employees against liabilities that may arise by reason of their status or service as directors or officers, and to advance their expenses incurred as a result of any legal proceeding against them as to which they could be indemnified.

There is no maximum limit on the indemnification that may be required under these obligations.

As of July 3, 2020, we have not incurred any material costs related to these indemnification obligations.

As a result, we believe the estimated fair value of these obligations is minimal.

We also have indemnification obligations to our directors and officers and certain of our employees that serve as officers or directors of our foreign subsidiaries that may require us to indemnify our directors and officers and those certain employees against liabilities that may arise by reason of their status or service as directors or officers, and to advance their expenses incurred as a result of any legal proceeding against them as to which they could be indemnified.

Recent Accounting Standards or Updates Not Yet Effective

See Note 1, “Summary of Significant Accounting Policies” of the notes to the condensed consolidated financial statements for a description of recent accounting standards, including the expected dates of adoption and the estimated effects on our condensed consolidated financial statements.

See Note 1, “Summary of Significant Accounting Policies” of the notes to the accompanying condensed consolidated financial statements for a description of recent accounting standards, including the expected dates of adoption and the estimated effects on our condensed consolidated financial statements.

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 total backlog at January 1, 2021 was $260.1 million.

The Company expects to recognize this backlog as revenue over the next 12 months, however, 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.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis