Varex Imaging Corp 10-Q

Item 2. 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 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”). 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: the impact of the ongoing COVID-19 pandemic on the global economy or the Company; supply chain actions; industry or market segment outlook; market acceptance of or transition to new products or technology such as advanced X-ray tube and digital flat panel detector products; growth drivers; future orders, revenues, backlog, earnings or other financial results; 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. 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. Overview 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. Our products are sold in three geographic regions: the Americas, EMEA, and APAC. The Americas includes North America (primarily the United States) and Latin America. EMEA includes Europe, Russia, the Middle East, India and Africa. APAC includes Asia and Australia. Revenues by region are based on the known final destination of products sold. 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 approximately 400 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. 27 Table of Contents Impact of COVID-19 and the General Economic Environment Over the past 18 months, the unprecedented nature of the COVID-19 pandemic and its effect on the global economy significantly disrupted our business by increasing uncertainty in demand for our products as well as increasing variability in our supply chain and manufacturing productivity. The economic downturn triggered by COVID-19 also led to significantly lower demand from our customers and delays in equipment installations. During the three months ended July 2, 2021, demand for many of our products has continued to recover and our business has continued to stabilize. We believe that demand for our products has increased in part because end-users (such as hospitals) are making capital purchases that were previously deferred due to the uncertainty surrounding COVID-19. It remains difficult to forecast future demand and there is no guarantee that the increase in demand will continue once the current backlog has been satisfied. While we are encouraged by the recovery that we have seen, we remain cautious as many factors remain unpredictable. In particular, new variants of the COVID-19 virus and uneven vaccination rates across the globe continue to make it difficult to forecast the trajectory and speed of any future recovery. We continue to experience logistic, supply chain, and manufacturing challenges that we expect will continue into 2022. As economies around the world begin to recover, shortages in raw materials have become more widespread. During the three months ended July 2, 2021, we experienced shortages of materials and have 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 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 over the last few months and are expected to continue. During the three months ended July 2, 2021, our manufacturing facilities continued to operate with minimal disruption. In accordance with government guidelines, we have begun to modify certain COVID-19 related protocols, including social distancing and mask requirements. In the event COVID-19 cases continue an upward trajectory, we may be required to re-implement certain COVID-19 related precautions. 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 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 risks that could impact our results, see Part II, Item 1A - Risk Factors. Operating Segments and Products Our Chief Executive Officer, who is our Chief Operating Decision Maker (“CODM”), evaluates our product groupings and measures our business performance in two reportable operating segments: Medical and Industrial. 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 profit. Medical 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. 28 Table of Contents Our X-ray imaging components are sold primarily to OEM customers, which integrate 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 a number of 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-Chinese 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. Industrial 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 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 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 and 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. 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. 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 reduced the demand for X-ray imaging equipment utilized in the non-destructive testing market as manufacturers focused on cash preservation and reduced spending for capital equipment. During the three months ended July 2, 2021, we have continued to see improved conditions in this market. Separately, the unprecedented decrease in passenger air traffic has led to a decrease in demand in the security market. 29 Table of Contents Critical Accounting Policies and Estimates The preparation of our condensed 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. 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 income taxes. 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 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. Fiscal Year 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 2020 was the 53-week period that ended on October 2, 2020. The fiscal quarters ended July 2, 2021 and July 3, 2020 were both 13-week periods. On a year-to-date basis, the three fiscal quarters ended July 2, 2021 and July 3, 2020 were 39 weeks and 40 weeks, respectively. Discussion of Results of Operations for the Three Months Ended July 2, 2021 Compared to the Three Months Ended July 3, 2020 Revenues, net Three Months Ended (In millions) July 2, 2021 July 3, 2020 $ Change % Change Medical $ 167.3 $ 137.6 $ 29.7 21.6 % Industrial 43.9 33.6 10.3 30.7 % Total revenues $ 211.2 $ 171.2 $ 40.0 23.4 % Medical as a percentage of total revenues 79.2 % 80.4 % Industrial as a percentage of total revenues 20.8 % 19.6 % Medical revenues increased $29.7 million primarily due to increased sales of digital detectors for dynamic imaging applications and higher sales of CT X-ray tubes. Industrial revenues increased $10.3 million primarily due to increased sales of digital detectors, X-ray tubes, and connectors for security and non-destructive inspection applications. 30 Table of Contents Gross Profit Three Months Ended (In millions) July 2, 2021 July 3, 2020 $ Change % Change Medical $ 56.5 $ 18.0 $ 38.5 213.9 % Industrial 17.6 8.3 9.3 112.0 % Total gross profit $ 74.1 $ 26.3 $ 47.8 181.7 % Medical gross margin 33.8 % 13.1 % Industrial gross margin 40.1 % 24.7 % Total gross margin 35.1 % 15.4 % The increase in Medical gross profit was primarily due to the increased sales of digital detectors for dynamic imaging applications, the impacts of cost reduction measures taken by management in previous quarters and a favorable product mix in medical detectors. Also during the three months ended July 3, 2020, there was a $13 million charge for the write-down of inventory associated with discontinued products and restructuring activity. The Industrial segment gross profit increased as a result of increased sales of digital detectors for security and non-destructive inspection applications. Also during the three months ended July 3, 2020, there was a $3 million charge for the write-down of inventory associated with discontinued products and restructuring activity. Operating Expenses Three Months Ended (In millions) July 2, 2021 July 3, 2020 $ Change % Change Research and development $ 19.2 $ 19.0 $ 0.2 1.1 % As a percentage of total revenues 9.1 % 11.1 % Selling, general and administrative $ 29.2 $ 31.4 $ (2.2) (7.0) % As a percentage of total revenues 13.8 % 18.3 % Impairment of intangible assets $ — $ 2.7 $ (2.7) (100.0) % As a percentage of total revenues — % 1.6 % Operating expenses $ 48.4 $ 53.1 $ (4.7) (8.9) % As a percentage of total revenues 22.9 % 31.0 % Research and Development 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. Research and development costs decreased to 9.1% of revenues for the third quarter of 2021 primarily due to increased revenues, cost actions and improved material cost management. Selling, General and Administrative Selling, general and administrative expenses for the third quarter of 2021 decreased $2.2 million and decreased to 13.8% of total revenues primarily due to lower external audit, consulting and legal costs compared to the prior year quarter and cost reduction actions taken by management in prior quarters. Interest and Other Expense, Net The following table summarizes the Company’s interest and other expense, net: Three Months Ended (In millions) July 2, 2021 July 3, 2020 $ Change Interest expense (10.6) (6.9) (3.7) Other income (expense), net 0.2 (6.1) 6.3 Interest and other expense, net $ (10.4) $ (13.0) $ 2.6 31 Table of Contents Interest and other expense, net decreased during the three months ended July 2, 2021 compared to the prior year period, primarily due to lower other expenses, net, which were partially offset by higher interest expense. Interest expense increased due to the interest related to our Convertible Notes issued during June 2020 and the issuance of our Senior Secured Notes in September 2020 which had higher interest rates. Other expense, net decreased for the three months ended July 2, 2021, compared to the three months ended July 3, 2020. Other expense, net during the three months ended July 3, 2020, consisted primarily of the impairment of certain investments in privately-held companies and an increase in the fair value of the deferred consideration related to the Direct Conversion acquisition, which did not recur during the three months ended July 2, 2021. Taxes on Income (Loss) For the three months ended July 2, 2021, we recognized income tax expense of $3.1 million on a $15.3 million pre-tax income. We are unable to recognize a tax benefit for pre-tax book losses in certain foreign jurisdictions. For the three months ended July 3, 2020, we recognized income tax benefit of $11.6 million on $39.8 million of pre-tax loss. Our tax expense for the three months ended July 2, 2021 increased, compared to the prior year, primarily due to increased pre-tax income in certain jurisdictions. Discussion of Results of Operations for the Nine Months Ended July 2, 2021 Compared to the Nine Months Ended July 3, 2020 The nine months ended July 2, 2021 and July 3, 2020 consisted of 39 weeks and 40 weeks, respectively. In the narrative text below, we do not highlight the differences between periods due to the extra week of operations in the 2020 period. Revenues Nine Months Ended (In millions) July 2, 2021 July 3, 2020 $ Change % Change Medical $ 463.1 $ 448.6 $ 14.5 3.2 % Industrial 128.7 119.7 9.0 7.5 % Total revenues $ 591.8 $ 568.3 $ 23.5 4.1 % Medical as a percentage of total revenues 78.3 % 78.9 % Industrial as a percentage of total revenues 21.7 % 21.1 % Medical revenues increased $14.5 million primarily due to increased sales of CT X-ray tubes, digital detectors for dynamic imaging applications and decreased sales of radiographic digital detectors. Industrial revenues increased $9.0 million due to increased sales of linear accelerators for cargo inspection and other non-destructive inspection applications, and an increase in sales of digital detectors for security and non-destructive inspection applications. Gross Profit Nine Months Ended (In millions) July 2, 2021 July 3, 2020 $ Change % Change Medical $ 146.3 $ 105.2 $ 41.1 39.1 % Industrial 49.6 39.8 9.8 24.6 % Total gross profit $ 195.9 $ 145.0 $ 50.9 35.1 % Medical gross margin % 31.6 % 23.5 % Industrial gross margin % 38.5 % 33.2 % Total gross margin % 33.1 % 25.5 % The increase in Medical gross profit was primarily due to a favorable mix of higher margin products and the impacts of cost reduction measures taken by management in previous quarters. Also during the nine months ended July 3, 2020, there was a $13 million charge for the write-down of inventory associated with discontinued products and restructuring activity. The Industrial gross 32 Table of Contents profit increased due to a favorable mix of higher margin industrial detector products. Also during the nine months ended July 3, 2020, there was a $3 million charge for the write-down of inventory associated with discontinued products and restructuring activity. Operating Expenses Nine Months Ended (In millions) July 2, 2021 July 3, 2020 $ Change % Change Research and development $ 54.1 $ 61.6 $ (7.5) (12.2) % As a percentage of total revenues 9.1 % 10.8 % Selling, general and administrative $ 94.2 $ 101.5 $ (7.3) (7.2) % As a percentage of total revenues 15.9 % 17.9 % Impairment of intangible assets $ — $ 2.7 $ (2.7) (100.0) % As a percentage of total revenues — % 0.5 % Operating expenses $ 148.3 $ 165.8 $ (17.5) (10.6) % As a percentage of total revenues 25.1 % 29.2 % Research and Development 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. Research and development costs decreased to 9.1% of revenues due to cost actions taken by management in previous quarters and improved material cost management. Selling, General and Administrative Selling, general and administrative expenses for the nine months ended July 2, 2021, decreased to 15.9% primarily due to lower external audit, consulting and legal costs and cost actions taken by management in previous quarters. 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 2, 2021 July 3, 2020 $ Change Interest income $ — $ 0.1 $ (0.1) Interest expense (31.3) (16.9) (14.4) Other income (expense), net (2.5) (4.5) 2.0 Interest and other expense, net $ (33.8) $ (21.3) $ (12.5) Interest and other expense, net increased during the nine months ended July 2, 2021. Interest expense increased due to the interest related to our Convertible Notes issued during June 2020 and the issuance of our Senior Secured Notes in September 2020 which had higher interest rates. Other expense, net decreased during the nine months ended July 2, 2021 as compared to the nine months ended July 3, 2020. Other expense, net during the nine months ended July 3, 2020 consisted primarily of 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, which did not recur during the nine months ended July 2, 2021. Taxes on Income (Loss) For the nine months ended July 2, 2021, we recognized an income tax expense of $4.7 million on $13.8 million of pre-tax income. 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 nine months ended July 3, 2020, the Company recognized income tax benefit of $10.9 million on $42.1 million of pre-tax loss. Our tax expense for the nine months ended July 2, 2021 increased, compared to the prior year, primarily due to pre-tax income and valuation allowances in the U.S. on credits and disallowed interest expense deductions and losses in certain foreign jurisdictions for which no benefit can be recorded. 33 Table of Contents 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 and availability under our Asset-Based Loan ("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. The maximum availability under our ABL Facility is $100.0 million; however, the borrowing base under the ABL Facility fluctuates from month-to-month depending on the amount of eligible accounts receivable, inventory, and real estate. As of July 2, 2021 the amount available under our ABL Facility was $70 million, and the ABL Facility remains undrawn. See Part II, Item 1A. “Risk Factors” for a further discussion. At July 2, 2021 we had $429.8 million in long-term debt and $32.9 million of current maturities of long-term debt, net of deferred issuance costs of $49.0 million. On July 1, 2021, we announced, and completed on July 15, 2021, the partial redemption in the principal amount of $30 million of our $300 million 7.875% Senior Secured Notes due 2027 (the "Senior Secured Notes"), in accordance with the terms and conditions of the governing indenture. The redemption price of the redeemed notes was 103% of the principal amount of the Senior Secured Notes, plus accrued and unpaid interest from, and including, April 15, 2021 to, but excluding, the redemption date of July 15, 2021. On July 15, 2021, the Company redeemed $30 million of Senior Secure Notes by paying cash of $31.5 million, inclusive of the redemption premium and accrued interest, and recognized a $1.4 million loss related to the redemption premium and the write-off of previously recorded debt issuance costs. See Note 10. 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 2, 2021 October 2, 2020 $ Change Cash and cash equivalents $ 128.3 $ 100.6 $ 27.7 Borrowings The following table summarizes the changes in our debt outstanding: July 2, 2021 October 2, 2020 (In millions, except for percentages) Amount Amount $ Change Current maturities of long-term debt Senior Secured Notes $ 30.0 $ — $ 30.0 Other debt $ 2.9 $ 2.5 $ 0.4 Total current maturities of long-term debt $ 32.9 $ 2.5 $ 30.4 Non-current maturities of long-term debt: Asset-Based Loan $ — $ — $ — Convertible Senior Unsecured Notes 200.0 200.0 — Senior Secured Notes 270.0 300.0 (30.0) Other debt 8.8 8.8 — Total non-current maturities of long-term debt: $ 478.8 $ 508.8 $ (30.0) Unamortized issuance costs and debt discounts Unamortized discount - Convertible Notes $ (39.6) $ (45.5) $ 5.9 Unamortized issuance costs - Convertible Notes (4.3) (4.9) 0.6 Unamortized issuance costs - Senior Secured Notes (5.1) (5.6) 0.5 Total $ (49.0) $ (56.0) $ 7.0 Total debt outstanding, net $ 462.7 $ 455.3 $ 7.4 34 Table of Contents Cash Flows Nine Months Ended (In millions) July 2, 2021 July 3, 2020 Net cash flow provided by (used in): Operating activities $ 42.0 $ 25.0 Investing activities (12.9) (23.2) Financing activities (1.3) 56.7 Effects of exchange rate changes on cash and cash equivalents and restricted cash (0.1) (1.0) Net increase in cash and cash equivalents and restricted cash $ 27.7 $ 57.5 Net Cash Provided by Operating Activities. Cash from operating activities consists primarily of the net income (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 nine months ended July 2, 2021, compared to the nine months ended July 3, 2020, cash provided by operating activities were as follows: • Net income of $9.1 million compared to a loss of $(31.2) million • Non-cash adjustments to net income (loss) of $53.1 million compared to $50.8 million • Operating assets and liabilities activity: ◦ Accounts receivable increased by $25.5 million compared to a decrease of $31.6 million, ◦ Inventories decreased by $24.6 million compared to an increase of $50.1 million, ◦ Prepaid expenses and other assets increased by $14.6 million compared to $7.7 million, ◦ Accounts payable decreased by $6.0 million compared to an increase of $21.7 million, and ◦ Accrued liabilities and other current and long-term operating liabilities increased by $1.2 million compared to $11.0 million. Net Cash Used in Investing Activities. Net cash used in investing activities was $12.9 million and $23.2 million for the nine months ended July 2, 2021 and July 3, 2020, respectively. The decrease in cash used in investing activities was primarily due to higher capital spending during the nine months ended July 3, 2020. Net Cash (Used in) Provided by Financing Activities. We used $1.3 million of cash in financing activities for the nine months ended July 2, 2021. Net cash provided by financing activity for the nine months ended July 3, 2020, was primarily due to our 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 underlay 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 underlay 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. Days Sales Outstanding Trade accounts receivable days sales outstanding (“DSO”) was 64 days at July 2, 2021 and 66 days at October 2, 2020. 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. Contractual Obligations 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. In January 2021, the total fixed cost commitment was $11.6 million for calendar year 2021. As of July 2, 2021, we estimate that we have fixed cost commitments of $5.8 million related to this amended agreement through the remainder of calendar year 2021. The amended agreement will continue unless the ownership structure of dpiX changes (as defined in the amended agreement). 35 Table of Contents In October 2015, pursuant to a Domination and Profit and Loss Transfer Agreement (the “MeVis Agreement”), we committed to pay 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 July 2, 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 July 2, 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 $9.7 million. Contingencies 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 July 2, 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, 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 2, 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 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 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 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 July 2, 2021 was approximately $259 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.