Forward-Looking Statements
This Annual Report on Form 10-K (this “Annual Report”), including the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (“MD&A”) 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 is subject to risks and uncertainties. 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 due to the factors cited in the Risk Factors listed under Part I, Item 1A of this Annual Report, MD&A and other factors described from time to time in our other filings with the U.S. Securities and Exchange Commission (the “SEC”), or other reasons. For this purpose, statements concerning: 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. 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.
PART I
Item 1. Business
Overview
Varex Imaging Corporation, a Delaware corporation formed in 2016, is a leading innovator, designer and manufacturer of X-ray imaging components, which include X-ray tubes, digital flat panel detectors and linear accelerators, which are key components of X-ray imaging systems. On January 28, 2017, Varian Medical Systems, Inc. ("Varian") completed its separation and distribution of Varex. In connection with the distribution, Varex became an independent publicly-traded company and is listed on The NASDAQ Global Select Market under the ticker “VREX” with 37.4 million shares of common stock distributed to Varian shareholders. With a 65+ year history of successful innovation, Varex’s components are used in medical imaging as well as in industrial and security imaging applications. Global OEM manufacturers of X-ray imaging systems use the company’s X-ray sources, digital detectors, connecting devices and imaging software as components in their systems to detect, diagnose and protect.
On May 1, 2017, we acquired the Medical Imaging business of PerkinElmer, Inc. ("Acquired Detector Business") for $273.3 million. The acquisition consisted of PerkinElmer Medical Holdings, Inc. and Dexela Limited, together with certain assets of PKI and its direct and indirect subsidiaries relating to digital flat panel detectors that serve as components for industrial, medical, dental and veterinary X-ray imaging systems. The acquired business included approximately 280 employees with operations in Santa Clara, California as well as operations in Germany, the Netherlands and the United Kingdom.
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 upon our ability to anticipate changes in our markets, the direction of technological innovation and the demands of our customers. We continue to invest in research and development and have over 500 engineers (including 55 with a doctorate degree) in the company. 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. In addition, total product lifecycle cost is important. We continue 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.
Our Chief Executive Officer, who is our Chief Operating Decision Maker (“CODM”), evaluates the product groupings and measures the 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 margin.
In our Medical business segment, we design, manufacture, sell and service X-ray imaging components for use in a range of applications, including radiographic and fluoroscopic imaging, mammography, computed tomography (“CT”), radiation therapy and computer-aided detection. We provide a broad range of X-ray imaging components for medical customers, including X-ray tubes, digital flat panel image detectors, high voltage connectors, image-processing software and workstations, computer-aided diagnostic software, collimators, automatic exposure control devices, generators, 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 dental 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 flat panel detector market continues to mature from initial product introductions more than 10 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 imaging system original equipment manufacturer (“OEM”) customers that incorporate them into their medical diagnostic, radiation therapy, dental and veterinary imaging systems. 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.
In our Industrial business segment, we design, manufacture, sell and service products for use in security and industrial inspection applications, such as airport security screening at ports and borders and nondestructive examination in a variety of applications. The products include Linatron X-ray accelerators, X-ray tubes, digital flat panel detectors, high voltage connectors and image-processing software that we generally sell to OEM customers that incorporate these products into their inspection systems.
The security market primarily consists of airport security (carry-on baggage, checked baggage and palletized cargo) and cargo screening 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. In 2015, we saw a significant decline in demand for border protection systems due to the volatility of oil prices with moderate increases in demand in the following years.
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, food packaging, metal castings and 3D printing industries. We provide x-ray sources, digital flat panel detectors, high voltage connectors and image processing software to OEM customers, system integrators and manufacturers. In addition, new applications for x-ray sources are being developed, such as sterilization of food and its packaging.
Customers
Varex’s customers are primarily large OEMs. Its top five customers, measured by revenue, are Toshiba Medical Systems, Hologic, Inc., Hitachi Ltd., General Electric Company and Varian, which collectively accounted for approximately 34% of Varex’s revenues in fiscal year 2017. Varex’s largest customer, Toshiba Medical Systems, accounted for approximately 19%, 23% and 26% of its total revenues in fiscal 2017, 2016 and 2015 respectively. The loss of one or more of Varex’s top customers would have a material and adverse effect on Varex’s business. For more information, see “Risk Factors—Varex sells its products to a limited number of OEM customers, many of which are also its competitors, and a reduction in or loss of business of one or more of these customers may materially reduce its sales.”
Competition
The imaging components market is highly competitive. Our OEM customers may choose to develop and manufacture the components in-house or they may choose to out-source to a supplier such as Varex or other providers of imaging components. Our success depends upon our ability to anticipate changes in our markets, the direction of technological innovation and the demands of our customers. To remain competitive, we must continue to invest in research and development focused on innovation, product performance and improving the quality and cost of our imaging components. Significant capital investment is required for imaging
component manufacturers and Varex leverages its high volume to reduce its per-unit costs by spreading the fixed costs over more units.
Varex often competes with the in-house X-ray tube manufacturing operations of major diagnostic imaging systems companies, which are the primary OEM customers for Varex’s Medical products. In order to effectively compete with these in-house
alternatives, Varex must have a competitive advantage in one or more significant areas, such as superior technology and performance,
better product quality or lower product cost. Consequently, Varex sells a significant volume of its X-ray tubes to OEM customers that have in-house X-ray tube production capability. In addition, Varex competes with some OEM customers, such as Toshiba Medical Systems Corporation and Dunlee, a division of Philips Healthcare, who sell X-ray tubes to other manufacturers, and other non-OEMs, such as Industria Applicazioni Elettroniche S.p.A, as well as emerging X-ray tube manufacturers in China. High capital costs and mastery of complex manufacturing processes that drive production yield and product life are significant characteristics of the X-ray tubes business.
The market for digital flat panel detectors is also very competitive. Varex sells its digital flat panel detectors to a number of OEM customers that incorporate Varex’s flat panel detectors into their medical diagnostic, radiation therapy, dental, veterinary and industrial imaging systems. Varex’s amorphous silicon based flat panel detector technology and complementary metal-oxide-semiconductor ("CMOS") technology competes with other detector technologies, such as amorphous selenium, charge-coupled devices and variations of amorphous silicon scintillators. Varex believes that its products provide a competitive advantage due to product quality and performance and lower overall product lifecycle costs. In the digital flat panel detector market, Varex primarily competes against Trixell S.A.S., Canon, Inc., Vieworks Co., Ltd., and Hamamatsu Corporation, as well as emerging low-cost manufacturers from China such as iRay Technology (Shanghai) Limited, and Jiangsu CareRay Medical Systems Co., Ltd.