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EX-32.2 - EXHIBIT 32.2 - Varex Imaging Corpvarexq3exhibit322.htm
EX-32.1 - EXHIBIT 32.1 - Varex Imaging Corpvarexq3exhibit321.htm
EX-31.2 - EXHIBIT 31.2 - Varex Imaging Corpvarexq3exhibit312.htm
EX-31.1 - EXHIBIT 31.1 - Varex Imaging Corpvarexq3exhibit311.htm
EX-10.1 - EXHIBIT 10.1 - Varex Imaging Corpvarexq3exhibit101.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 ____________________________________________________________
FORM 10-Q
 ____________________________________________________________
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2017
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number 001-37860
 ____________________________________________________________ 
logoa09.jpg
VAREX IMAGING CORPORATION
(Exact name of registrant as specified in its charter)
 ____________________________________________________________ 
Delaware
 
81-3434516
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
1678 S. Pioneer Road,
Salt Lake City, Utah
 
84104
(Address of principal executive offices)
 
(Zip Code)
(801) 972-5000
(Registrant’s telephone number, including area code)
 ____________________________________________________________ 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   ý No   ¨     
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes   ý     No   ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
 
 
 
 
 
 
 
 
Large Accelerated filer
 
o
 
Accelerated filer
 
o
 
 
 
 
 
 
 
Non-Accelerated filer
 
x  
 
Smaller reporting company
 
o
 
 
 
 
 
 
 
 
 
 
 
Emerging growth company
 
x
 
 
 
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
 
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  ¨  No  ý
As of July 31, 2017, there were 37,631,322 shares of the registrant’s common stock outstanding.




VAREX IMAGING CORPORATION
FORM 10-Q for the Quarter Ended June 30, 2017
INDEX
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


1


PART I
FINANCIAL INFORMATION

Item 1. Financial Statements

VAREX IMAGING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
 

Three Months Ended
 
Nine Months Ended
(In millions, except per share amounts)
June 30, 2017
 
July 1, 2016
 
June 30, 2017
 
July 1, 2016
Revenues
$
170.1

 
$
151.4

 
$
482.4


$
448.0

Cost of revenues
110.6

 
88.4

 
306.6


268.8

Gross margin
59.5

 
63.0

 
175.8


179.2

Operating expenses:
 
 
 
 





Research and development
17.7

 
14.0

 
45.4


39.6

Selling, general and administrative
26.3

 
20.6

 
73.3


63.5

Total operating expenses
44.0

 
34.6

 
118.7


103.1

Operating earnings
15.5

 
28.4

 
57.1


76.1

Interest income
0.1

 
0.1

 
0.2


0.4

Interest expense
(4.2
)
 
(0.4
)
 
(5.8
)

(1.3
)
Other income (expense), net
4.4

 
(1.0
)
 
5.1


(2.0
)
Interest and other income (expense), net
0.3

 
(1.3
)
 
(0.5
)

(2.9
)
Earnings before taxes
15.8

 
27.1

 
56.6


73.2

Taxes on earnings
5.1

 
9.3

 
19.6


26.4

Net earnings
10.7

 
17.8

 
37.0


46.8

Less: Net earnings attributable to noncontrolling interests
0.1

 
0.2

 
0.2


0.3

Net earnings attributable to Varex
$
10.6

 
$
17.6

 
$
36.8


$
46.5

Net earnings per common share attributable to Varex
 
 
 
 
 
 
 
Basic
$
0.28

 
$
0.47

 
$
0.98

 
$
1.24

Diluted
$
0.28

 
$
0.47

 
$
0.97

 
$
1.23

Weighted average common shares outstanding
 
 
 
 
 
 
 
Basic
37.6

 
37.4

 
37.5

 
37.4

Diluted
38.0

 
37.7

 
37.9

 
37.7

 
See accompanying notes to the condensed consolidated financial statements.

2




VAREX IMAGING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS
(Unaudited)


Three Months Ended
 
Nine Months Ended
(In millions)
June 30, 2017
 
July 1, 2016
 
June 30, 2017
 
July 1, 2016
Net earnings
$
10.7

 
$
17.8

 
$
37.0


$
46.8

Other comprehensive earnings (loss), net of tax:
 
 
 
 





Unrealized gain on interest rate swap contracts, net of tax expense of $0.2 during the three and nine months ended June 30, 2017
0.4

 

 
0.4

 

Available-for-sale securities:
 
 
 
 





Change in unrealized loss, net of tax benefit of $0 for the three months ended June 30, 2017 and 2016, respectively, and $0 and $0.1 during the nine months ended June 30, 2017 and July 1, 2016, respectively

 

 


(0.3
)
Reclassification adjustments, net of tax expense of $0 for the three months ended June 30, 2017 and 2016, respectively, and $0 and ($0.2) during the nine months ended June 30, 2017 and July 1, 2016, respectively

 

 


0.4

Other comprehensive earnings, net of tax
0.4

 

 
0.4


0.1

Comprehensive earnings
11.1

 
17.8

 
37.4


46.9

Less: Comprehensive earnings attributable to noncontrolling interests
0.1

 
0.2

 
0.2


0.3

Comprehensive earnings attributable to Varex
$
11.0

 
$
17.6

 
$
37.2


$
46.6

 
 
  
 See accompanying notes to the condensed consolidated financial statements.




3


VAREX IMAGING CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In millions, except per share amounts)
June 30, 2017
 
September 30, 2016
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
89.3

 
$
36.5

Accounts receivable, net
133.1

 
122.2

Inventories, net
256.3

 
197.4

Prepaid expenses and other current assets
27.6

 
3.8

Total current assets
506.3

 
359.9

Property, plant and equipment, net
138.7

 
108.9

Goodwill
243.3

 
74.7

Intangibles assets
95.5

 
20.7

Investments in privately-held companies
52.0

 
49.3

Deferred tax assets

 
5.5

Other assets
10.7

 
3.4

Total assets
$
1,046.5

 
$
622.4

Liabilities, Redeemable Noncontrolling Interests and Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
62.2

 
$
41.9

Accrued liabilities
61.1

 
23.9

Current maturities of long-term debt
20.0

 

Deferred revenues
10.0

 
12.0

Total current liabilities
153.3

 
77.8

Long-term debt
478.7

 

Deferred tax liabilities
36.7

 
3.0

Other long-term liabilities
8.4

 
5.3

Total liabilities
677.1

 
86.1

Commitments and contingencies (Note 11)
 
 
 
Redeemable noncontrolling interests
10.3

 
10.3

Equity:
 
 
 
Preferred stock, $.01 par value: 20,000,000 shares authorized, none issued

 

Common stock, $.01 par value:
 
 
 
Authorized shares - 150,000,000
 
 
 
Issued shares - 37,630,219 and 0
 
 
 
Outstanding shares - 37,630,219 and 0
0.4

 

Net parent investment

 
526.0

Additional paid-in capital
338.2

 

Accumulated other comprehensive loss
0.4

 

Retained earnings
20.1

 

Total stockholders' equity
359.1

 
526.0

Total liabilities, redeemable noncontrolling interests and Varex stockholders' equity
$
1,046.5

 
$
622.4

  
See accompanying notes to the condensed consolidated financial statements.

4


VAREX IMAGING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

Nine Months Ended
(In millions)
June 30, 2017
 
July 1, 2016
Cash flows from operating activities:
 
 
 
Net earnings
$
37.0


$
46.8

Adjustments to reconcile net earnings to net cash provided by operating activities:





Share-based compensation expense
6.1


7.0

Tax effect of (windfalls) shortfalls from share-based compensation


(0.3
)
Depreciation
10.6


7.2

Amortization of intangible assets
6.2


4.2

Deferred taxes
7.8


1.0

(Income) loss from equity method investments
(3.0
)

1.1

Amortization of deferred loan costs
0.6

 

Other, net
0.6


0.6

Changes in assets and liabilities:





Accounts receivable
7.2


8.8

Inventories
(24.1
)

(22.6
)
Prepaid expenses and other assets
(7.4
)

0.4

Accounts payable
10.7


(1.5
)
Accrued operating liabilities and other long-term operating liabilities
9.5


(0.2
)
Deferred revenues
(2.0
)

1.9

Net cash provided by operating activities
59.8


54.4

Cash flows from investing activities:





Purchases of property, plant and equipment
(7.6
)

(24.2
)
Sale of available-for-sale securities


8.6

Acquisitions of businesses, net of cash acquired
(276.0
)

(1.2
)
Other


(0.1
)
Net cash used in investing activities
(283.6
)

(16.9
)
Cash flows from financing activities:





Net transfers from (to) parent
3.3

 
(24.4
)
Distribution to Varian Medical Systems, Inc.
(227.1
)
 

Taxes related to net share settlement of equity awards
(1.9
)
 

Borrowings under credit agreements
744.0

 

Repayments of borrowing under credit agreements
(234.0
)
 

Proceeds from exercise of stock options
2.8

 

Excess tax benefits from share-based compensation

 
0.3

Payment of debt issuance costs
(11.9
)
 

Other financing activities
0.7

 

Net cash provided by (used in) financing activities
275.9


(24.1
)
Effects of exchange rate changes on cash and cash equivalents
0.7


0.1

Net increase in cash and cash equivalents
52.8


13.5

Cash and cash equivalents at beginning of period
36.5


20.6

Cash and cash equivalents at end of period
$
89.3


$
34.1

Supplemental cash flow information:
 
 
 
Cash paid for interest
$
4.4

 
$

Cash paid for income tax
2.6

 

Supplemental non-cash activities:
 
 
 
Purchases of property, plant and equipment financed through accounts payable
$
1.4

 
$
3.6

Transfers of property, plant and equipment from Varian Medical Systems, Inc.
13.8

 

See accompanying notes to the condensed consolidated financial statements.


5


VAREX IMAGING CORPORATION
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. DESCRIPTION OF BUSINESS
Varex Imaging Corporation (the “Company,” “Varex” or “Varex Imaging”) designs, manufactures, sells and services a broad range of X-ray imaging components, including X-ray tubes, digital detectors and accessories, high voltage connectors, high-energy inspection accelerators, image processing software and workstations, computer-aided diagnostic software, collimators, automatic exposure control devices, generators, ionization chambers and buckys, for use in a range of applications, including radiographic or fluoroscopic imaging, mammography, special procedures, computed tomography, radio therapy and computer-aided detection. The Company sells its products to imaging system original equipment manufacturer (“OEM”) customers for incorporation into new medical diagnostic, radiation therapy, dental, veterinary and industrial imaging systems, to independent service companies, distributors and directly to end-users for replacement purposes.
The Company also designs, manufacturers, sells and services industrial products, which include Linatron® X-ray accelerators, imaging processing software and image detection products for security and inspection purposes, such as cargo screening at ports and borders and nondestructive examination in a variety of applications. The Company generally sells security and inspection products to OEM customers who incorporate Varex’s products into their inspection systems. The Company conducts an active research and development program to focus on new technology and applications in both the medical and industrial X-ray imaging markets.
Varex Imaging Corporation was incorporated in Delaware on July 18, 2016 for the purpose of holding the assets and liabilities associated with the Company's business and separated from Varian Medical Systems, Inc. ("Varian") on January 28, 2017, upon which Varian completed the distribution of 100% of the outstanding common stock of Varex to Varian stockholders. Each Varian stockholder received 0.4 of a share of Varex common stock for every one share of Varian common stock held on the close of business on January 20, 2017 (the “Record date”). Following the separation and distribution, Varex became an independent publicly-traded company and is listed on the NASDAQ Global Select Market under the ticker “VREX.”    
2. BASIS OF PRESENTATION AND PRINCIPLE OF CONSOLIDATION
The accompanying condensed consolidated financial statements are unaudited. These condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). In the opinion of management, these condensed consolidated financial statements include all adjustments necessary for the fair statement of the results for the interim periods. Prior to the date of separation and distribution, the financial statements were prepared on a stand-alone basis and are derived from Varian’s consolidated financial statements and records as it operated as part of Varian prior to the distribution, in conformity with GAAP.
The condensed consolidated financial statements include the accounts of the Company and certain other assets and liabilities that were historically held at the Varian corporate level but are specifically identifiable and attributable to the Company. Prior to the separation and distribution, the condensed consolidated financial statements included allocations of certain Varian corporate expenses, including costs of information technology, human resources, accounting, legal, facilities, insurance, treasury and other corporate and infrastructure services. In addition, allocated costs included research and development expenses from Varian’s scientific research facility. Prior to the separation, these costs were allocated to the Company on the basis of direct usage when identifiable or other systematic measures that reflect utilization of services provided to or benefits received by the Company. The Company considers the expense allocation methodology and results to be reasonable for all periods presented.
These condensed consolidated financial statements and the accompanying notes are unaudited and should be read in conjunction with the combined financial statements for the fiscal years ended 2016, 2015 and 2014 included in the Company’s Registration Statement on Form 10, which was filed with the SEC on January 12, 2017 (the “Form 10”).
 
The condensed consolidated financial position, results of operations, comprehensive earnings, statements of equity, and cash flows of the Company may not be indicative of its results had it been a separate stand-alone entity during the periods presented.

6


Prior to the separation, the Company was dependent upon Varian for its working capital and financing requirements, as Varian uses a centralized approach to cash management and financing of its operations. Financial transactions relating to the Company were accounted for through the net parent investment account. Cash and cash equivalents held by Varian were not allocated to the Company.
All transactions between the Company and Varian prior to the separation have been included in the accompanying condensed consolidated financial statements. All intercompany transactions while the Company operated as part of Varian were considered to be effectively settled for cash and are reflected as a component of financing activities as net transfers from (to) Varian in the condensed consolidated statements of cash flows at the time the transactions were recorded.
Net parent investment in the condensed consolidated balance sheets and statements of equity represents Varian’s historical investment in the Company, the net effect of transactions with and allocations from Varian and the Company’s accumulated earnings.
See Note 5, “Related Party Transactions” for further information regarding the Company’s relationships with Varian and other related-party transactions.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Segment Reporting
In fiscal year 2016, the Company re-aligned its reportable operating segments into (i) Medical and (ii) Industrial to align with how its CEO views and measures the Company’s business performance. The Company reclassified the segment data for the prior years to conform to the current year presentation. See Note 17, “Segment Information” for further information on the Company’s segments.
Fiscal Year
The fiscal years of the Company as reported are the 52 or 53-week period ending on the Friday nearest September 30. Fiscal year 2017 is the 52-week period ending September 29, 2017. Fiscal year 2016 was the 52-week period that ended on September 30, 2016. The third fiscal quarter of 2017 ended on June 30, 2017. The third fiscal quarter of 2016 ended on July 1, 2016.
Variable Interest Entities
For entities in which the Company has variable interests, the Company focuses on identifying which entity has the power to direct the activities that most significantly impact the variable interest entity’s economic performance and which enterprise has the obligation to absorb losses or the right to receive benefits from the variable interest entity. If the Company is the primary beneficiary of a variable interest entity, the assets, liabilities and results of operations of the variable interest entity will be included in the Company’s condensed consolidated financial statement. During the three and nine months ended June 30, 2017, the Company had three variable interest entities, only two of which were consolidated, because it was determined that the Company was the primary beneficiary for each entity.
 Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from these estimates.
Cash and Cash Equivalents
The Company considers currency on hand, demand deposits, time deposits and all highly-liquid investments with an original maturity of three months or less at the date of purchase to be cash and cash equivalents.

7


Fair Value
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. There is a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:
Level 1—Quoted prices in active markets for identical assets or liabilities.
Level 2—Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or, other inputs that are observable or can be corroborated by observable market data.
Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
Derivative instruments and hedging activities 
The Company records all derivatives on the balance sheet at fair value. For a derivative such as an interest rate swap that is designated as a cash flow hedge, the effective portion of changes in the fair value of the derivative is initially reported in accumulated other comprehensive income (loss) on the consolidated balance sheet and the ineffective portion of changes in the fair value of the derivative is recognized directly in earnings. To the extent the effective portion of a hedge subsequently becomes ineffective, the corresponding amount of the change in fair value of the derivative initially reported in accumulated other comprehensive income (loss) is reclassified and is recognized directly in earnings. Accordingly, on a quarterly basis, the Company assesses the effectiveness of each hedging relationship by comparing the changes in fair value or cash flows of the derivative hedging instrument with the changes in fair value or cash flows of a hypothetical designated perfect hedged item or transaction. If the change in the actual swap is greater than the change in the hypothetical perfect swap, the difference is referred to as “ineffectiveness” and is recognized in earnings in the current period.
Concentration of Risk
Financial instruments that potentially expose the Company to concentrations of credit risk consist principally of cash, cash equivalents and trade accounts receivable. Cash held with financial institutions may exceed the Federal Deposit Insurance Corporation insurance limits or similar limits in foreign jurisdictions. The Company has not experienced any losses on its deposits of cash and cash equivalents. The Company performs ongoing credit evaluations of its customers and, except for government tenders, group purchases and orders with a letter of credit, its industrial customers often provide a down payment. The Company maintains an allowance for doubtful accounts based upon the expected collectability of all accounts receivable. The Company obtains some of the components in its products from a limited group of suppliers or from a single-source supplier. The Company has neither experienced nor expects any significant disruptions to its operations due to supplier concentration.
Inventories
Inventories are valued at the lower of cost or market (realizable value). Excess and obsolete inventories are determined primarily based on future demand forecasts, and write-downs of excess and obsolete inventories are recorded as a component of cost of revenues. Cost is computed using standard cost (which approximates actual cost) on a first-in-first-out basis.
Property, Plant and Equipment
Property, plant and equipment are stated at cost, net of accumulated depreciation. Major improvements are capitalized, while repairs and maintenance are expensed as incurred. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets. Land is not subject to depreciation, but land improvements are depreciated over fifteen years. Land leasehold rights and leasehold improvements are amortized over the lesser of their estimated useful lives or remaining lease terms. Buildings are depreciated over twenty years. Machinery and equipment are depreciated over their estimated useful lives, which range from three to seven years. Assets subject to lease are amortized over the lesser of their estimated useful lives or remaining lease terms. Estimated useful lives are periodically reviewed and, when appropriate, changes are made prospectively. When certain events

8


or changes in operating conditions occur, asset lives may be adjusted, and an impairment assessment may be performed on the recoverability of the carrying amounts. When assets are retired or otherwise disposed of, the assets and related accumulated depreciation are removed from the accounts.
Investments
The Company accounts for its equity investments in privately-held companies under the equity method of accounting as the Company holds at least a 20% ownership interest or has the ability to exercise significant influence in these investments. The Company monitors these equity investments for impairment and makes appropriate reductions in carrying values if the Company determines that impairment charges are required based primarily on the financial condition and near-term prospects of these companies.
Goodwill and Intangible Assets
Goodwill is recorded when the purchase price of an acquisition exceeds the fair value of the net identified tangible and intangible assets acquired. Purchased intangible assets are carried at cost, net of accumulated amortization, and are included in other assets in the Company's condensed consolidated balance sheets. Intangible assets with finite lives are amortized over their estimated useful lives of primarily two to seven years using the straight-line method.
Impairment of Long-lived Assets, Intangible Assets and Goodwill
The Company reviews long-lived assets and identifiable intangible assets with finite lives for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. The Company assesses these assets for impairment based on their estimated undiscounted future cash flows. If the carrying value of the assets exceeds the estimated future undiscounted cash flows, the Company recognizes an impairment loss based on the excess of the carrying amount over the fair value of the assets. The Company did not recognize any impairment charges for long-lived assets and identifiable intangible assets during any of the periods presented.
The Company evaluates goodwill and indefinite lived intangible assets qualitatively for impairment at least annually in beginning of the fourth quarter of each fiscal year or whenever an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. If the Company determines that a quantitative analysis is necessary, the impairment test for goodwill is currently a two-step process. Step one consists of a comparison of the fair value of a reporting unit against its carrying amount, including the goodwill allocated to each reporting unit. The Company determines the fair value of its reporting units based on a combination of income and market approaches. The income approach is based on the present value of estimated future cash flows of the reporting units, and the market approach is based on a market multiple calculated for each reporting unit based on market data of other companies engaged in similar business. If the carrying amount of the reporting unit is in excess of its fair value, step two requires the comparison of the implied fair value of the reporting unit’s goodwill against the carrying amount of the reporting unit’s goodwill. Any excess of the carrying value of the reporting unit’s goodwill over the implied fair value of the reporting unit’s goodwill is recorded as an impairment loss. The impairment test for intangible assets with indefinite useful lives, if any, consists of a comparison of fair value to carrying value, with any excess of carrying value over fair value being recorded as an impairment loss.
As a result of the segment realignment in the fourth quarter of fiscal year 2016, goodwill was re-allocated to the Medical and Industrial reporting units based on their relative fair values. No impairment charges were recognized as a result of the change in reporting units. The Company performs its annual goodwill impairment analysis during the fourth quarter of its fiscal year.
Loss Contingencies
From time to time, the Company is a party to or otherwise involved in legal proceedings, claims and government inspections or investigations and other legal matters, both inside and outside the United States, arising in the ordinary course of its business or otherwise. The Company accrues amounts, 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 it believes will result in a probable loss.
Product Warranty

9


The Company warrants most of its products for a specific period of time, usually 12 to 24 months from delivery or acceptance, against material defects. The Company provides for the estimated future costs of warranty obligations in cost of revenues when the related revenues are recognized. The accrued warranty costs represent the best estimate at the time of sale of the total costs that the Company will incur to repair or replace product parts that fail while still under warranty. 
The amount of the accrued estimated warranty costs obligation for established products is primarily based on historical experience as to product failures adjusted for current information on repair costs. For new products, estimates include the historical experience of similar products, as well as reasonable allowance for warranty expenses associated with new products. On a quarterly basis, the Company reviews the accrued warranty costs and updates the historical warranty cost trends, if required.
Revenue Recognition
The Company’s revenues are derived primarily from the sale of hardware and software products, and services. The Company recognizes its revenues net of any value added or sales tax and net of sales discounts.
The Company sells a high proportion of its X-ray products to a limited number of OEM customers. X-ray tubes, digital detectors and image-processing tools and security and inspection products are generally sold on a stand-alone basis. However, the Company occasionally sells its digital detectors, X-ray tubes and imaging processing tools as a package that is optimized for digital X-ray imaging and sells its Linatron ® X-ray accelerators together with its imaging processing software and image detection products to OEM customers that incorporate them into their inspection systems. Service contracts are often sold with certain security and inspection products and computer-aided detection products. Revenues related to service contracts usually start after the expiration of the warranty period for non-software products or upon delivery of software products.
 
For a multiple-element arrangement that includes software and non-software deliverables which includes service contracts, the Company first allocates revenues among the software and non-software deliverables on a relative selling price basis. The amounts allocated to the non-software products and software are accounted for as follows:
Non-Software Products
Non-software products include hardware products, software components that function together with the hardware components to deliver the product’s essential functionality, as well as service contracts. Except as described below under “Service,” the Company recognizes revenues for non-software products when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable and collectability is reasonably assured.
For multiple-element revenue arrangements that involve non-software products, a delivered non-software element is considered as a separate unit of accounting when it has stand-alone value and there is no customer-negotiated refund or return rights for the delivered element. The allocation of revenue to all deliverables based on their relative selling prices is determined at the inception of the arrangement. The selling price for each deliverable is determined using vendor-specific objective evidence (“VSOE”) of selling price, if it exists; otherwise, third-party evidence of selling price (“TPE”) is used.
If the Company is not able to establish VSOE or TPE of selling prices for its non-software products, the Company uses the deliverable's estimated selling price (“ESP”). The Company estimates selling prices following an established process that considers market conditions, including the product offerings and pricing strategies of competitors, as well as internal factors such as historical pricing practices and margin objectives. The establishment of product and service ESPs is controlled and reviewed by the appropriate level of management in all of the Company’s businesses.
The Company recognizes revenues upon the transfer of risk of loss, which is either at the time of shipment or delivery, depending upon the terms of the contract, provided that all other revenue recognition criteria have been met.
Software Products
The Company recognizes revenues for software products in accordance with the software revenue recognition guidance. The Company recognizes license revenues when all of the following criteria have been met: persuasive evidence of an arrangement exists, the vendor’s fee is fixed or determinable, collection of the related receivable is probable and delivery of the product has occurred.

10


Revenues earned on software arrangements involving multiple elements are allocated to each element based on VSOE of fair value, which is based on the price charged when the same element is sold separately. In instances when evidence of VSOE of fair value of all undelivered elements exists, but evidence does not exist for one or more delivered elements, revenues are recognized using the residual method. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue. Revenue allocated to maintenance and support is recognized ratably over the maintenance term (typically one year).
For those software products that are not sold stand-alone or for which VSOE cannot be established or maintained, all software revenue under the contract will be deferred until the software product(s) that lack VSOE are all delivered. If the only undelivered software element that lacks VSOE is maintenance and support, then the software revenue would be recognized ratably over the term of the maintenance and support arrangement.
The Company recognizes revenues upon the transfer of risk of loss, which is either at the time of shipment or delivery, depending upon the shipping terms of the contract, provided that all other criteria for revenue recognition have been met.
 Service
Service revenues include revenues from hardware and software service contracts, bundled support arrangements, paid services and trainings and parts that are sold by the service department. Revenues allocated to service contracts are recognized ratably over the period of performance of the related contracts. Revenues related to services performed on a time-and-materials basis are recognized when they are earned and billable.
Deferred Revenues
Deferred revenue primarily represents (i) the amount billed, billable or received applicable to non-software products for which parts and services under the warranty contracts have not been delivered, (ii) the amount billed, billable or received applicable to software products for which the Company’s obligations under the maintenance contracts have not been fulfilled and (iii) the amount billed, billable or received for service contracts for which the services have not been rendered. Except for government tenders, group purchases and orders with letters of credit, the Company's security and inspection customers often provide a down payment prior to transfer of risk of loss of ordered products. These payments are also included in deferred revenue on the condensed consolidated balance sheets.
Share-Based Compensation Expense
The Company has an equity-based incentive plan that provides for the grant of nonqualified stock options and restricted stock units to directors, officers and other employees. The Company also permits employees to purchase shares under the Varex employee stock purchase plan. Prior to the separation, the Company’s employees historically participated in Varian’s equity-based incentive plans. Share-based compensation expense through the date of separation included allocations to the Company based on the awards and terms previously granted to its employees as well as an allocation of Varian’s corporate and shared functional employee expenses.
The Company values stock options granted and the option component of the shares of common stock purchased under the equity-based incentive plans and stock purchased under the employee stock purchase plan using the Black-Scholes option-pricing model. Share-based compensation expense for restricted stock units is measured using the fair value of the Company’s stock on the date of grant and is amortized over the award’s respective service period. The Black-Scholes option-pricing model requires the input of certain assumptions, and changes in the assumptions can materially affect the fair value estimates of share-based payment awards.
The Company measures and recognizes expense for all share-based payment awards based on their fair values. Share-based compensation expense recognized in the condensed consolidated statements of earnings includes compensation expense for the share-based payment awards based on the grant date fair value estimated in accordance with the guidance on share-based compensation. Share-based compensation expense recognized is based on the value of the portion of share-based payment awards that is ultimately expected to vest. The Company attributes the value of share-based compensation to expense using the straight-line method. The Company considers only the direct tax impacts of share-based compensation awards when calculating the amount of tax windfalls or shortfalls.
Shipping and Handling Costs

11


Shipping and handling costs are included as a component of cost of revenues.
Research and Development
Research and development costs have been expensed as incurred. These costs primarily include employees’ compensation, consulting fees and material costs.  
Software Development Costs
Costs for the development of new software products and substantial enhancements to existing software products are expensed as incurred until technological feasibility has been established, at which time any additional costs would be capitalized. No costs associated with the development of software have been capitalized, as the Company believes its current software development process is essentially completed concurrent with the establishment of technological feasibility.
Taxes on Earnings
Taxes on earnings, as presented, are calculated on a separate return basis. Under this method, the Company computes taxes on earnings as if it were a separate taxpayer filing its own income tax returns. The Company’s operations were historically included in Varian’s U.S. federal and state income tax returns and non-U.S. jurisdiction tax returns. Varian’s global tax structure has been developed based on its entire portfolio of businesses. Accordingly, the tax results as presented are not necessarily reflective of the results that the Company would have generated on a stand-alone basis. It is possible that the Company will make different tax accounting elections and assertions, such as the amount of earnings that will be indefinitely reinvested outside the United States. Consequently, post-separation tax results may be materially different than the historical results presented.
Generally, the carrying value of net deferred tax assets assumes that the Company will generate sufficient future taxable earnings in the applicable tax jurisdictions to utilize these deferred tax assets. Valuation allowances are recognized to reduce deferred tax assets to the amount that is more likely than not to be realized. Should management conclude that the Company will be unable to recover the net deferred tax assets in each jurisdiction, an increase in the valuation allowance would be recorded in the period in which that determination is made with a corresponding increase in the provision for income taxes.
Significant judgments and estimates are required in evaluating the Company’s tax positions and provision for taxes on earnings. The Company accounts for uncertainty in income taxes following a two-step approach for recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining whether the weight of available evidence indicates that it is more likely than not that, based on the technical merits, the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement. Recognition and measurement are based on management’s best judgment given the facts, circumstances and information available at the end of the accounting period.
The Company is subject to taxes on earnings in both the United States and numerous foreign jurisdictions. Foreign earnings are generally taxed at rates lower than United States rates, earnings in certain foreign jurisdictions are currently subject to tax in the United States, and the benefit of losses generated in other foreign jurisdictions is reduced due to full valuation allowance positions in those jurisdictions. Our effective tax rate is impacted by these factors as well as existing laws in both the United States and in the respective countries in which foreign subsidiaries do business. In addition, a change in the mix of earnings and losses among the various jurisdictions could increase or decrease our effective tax rate.
Foreign Currency Translation
The Company uses the U.S. Dollar as the functional currency of its foreign operations. Gains and losses from remeasurement of foreign currency balances into U.S. Dollars are included in the condensed consolidated statements of earnings. 
Recent Accounting Standards or Updates Not Yet Effective
In March 2016, the FASB issued Accounting Standard Update ("ASU") 2016-09 which includes an amendment to its accounting guidance related to employee share-based payments. The amendment simplifies several aspects of the accounting for employee share-based payments, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as

12


well as classification in the statement of cash flows. The amendment will be effective for the Company beginning in its first quarter of fiscal year 2018 with early adoption permitted. The Company is evaluating the impact of adopting this amendment to its condensed consolidated financial statements.
In January 2017, the FASB issued ASU 2017-04 which clarified its guidance to simplify the measurement of goodwill by eliminating the Step 2 impairment test. The new guidance requires companies to perform the goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. The amendment will be effective for the Company beginning in its first quarter of fiscal year 2021. The amendment is required to be adopted prospectively. Early adoption is permitted. The Company is evaluating the impact of adopting this amendment to its consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02 on accounting for leases. The new standard is intended to provide enhanced transparency and comparability by requiring lessees to record right-of-use assets and corresponding lease liabilities on the balance sheet. The new standard will continue to classify leases as either finance or operating, with classification affecting the pattern of expense recognition in the statement of earnings. The new standard is required to be adopted using a modified retrospective method to each prior reporting period presented with various optional practical expedients. The new standard will be effective for the Company beginning in its first quarter of fiscal year 2020 with early adoption permitted. The Company is evaluating the impact of adopting this new standard to its condensed consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, a new revenue standard, which sets forth a single, comprehensive revenue recognition model for all contracts with customers to improve comparability. The new standard requires revenue recognition to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In March 2016, the FASB amended the principal-versus-agent implementation guidance and illustrations in the new standard. In April 2016, the FASB amended the guidance on identifying performance obligations and the implementation guidance on licensing in the new standard. In May 2016, the FASB amended the guidance on collectability, noncash consideration, presentation of sales tax and transition in the new standard. The new standard will be effective for the Company beginning in its first quarter of fiscal year 2019, with early adoption permitted, but not before the first quarter of fiscal year 2018. The new standard can be applied either retrospectively to each prior reporting period presented (i.e., full retrospective adoption) or with the cumulative effect of initially applying the update recognized at the date of the initial application (i.e., modified retrospective adoption) along with additional disclosures. The Company is evaluating the timing and the impact of adopting this standard to its condensed consolidated financial statements.
4. BUSINESS COMBINATIONS
Acquisition of PerkinElmer’s Medical Imaging Business 
On May 1, 2017, the Company completed the acquisition of the PerkinElmer, Inc. (“PKI”) Medical Imaging business (“PKI Imaging”) for the initial purchase price of $277.4 million, or $273.3 million after post-closing working capital adjustments. 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 X-ray detectors that serve as components for industrial, medical, dental and veterinary X-ray imaging systems. PKI Imaging has about 280 employees, is headquartered in Santa Clara, California and has additional operations in Germany, the Netherlands and the United Kingdom. The acquisition of PKI Imaging was pursuant to the Master Purchase and Sale Agreement, dated December 21, 2016 (the “Purchase Agreement”), by and between PKI and Varian and the subsequent Assignment and Assumption Agreement, dated January 27, 2017, by and between Varian and Varex, pursuant to which Varian assigned and conveyed all of its rights, obligations, title and interest in the Purchase Agreement to Varex. The Company believes that the acquisition could result in opportunities to increase its imaging expertise and complement its existing imaging detector business while providing revenue and cost synergy opportunities over time.
On the Closing Date, Varex paid PKI and its subsidiaries approximately $277.4 million in cash to acquire PKI Imaging, which included $1.4 million of cash. Subsequent to the Closing Date, the initial purchase price was reduced by $4.2 million pursuant to the post-closing working capital adjustment, which resulted in total cash consideration for the acquisition of $273.3 million. This post-closing working capital adjustment is included in Other Current Assets in the Condensed Consolidated Balance Sheets at June 30, 2017.
The following amounts represent the determination of the fair value of identifiable assets acquired and liabilities for PKI Imaging:

13


(In millions)
Fair Value
Total cash consideration
$
273.3

 
 
Allocation of the purchase consideration:
 
Cash
$
1.4

Accounts Receivable
18.7

Inventory
34.7

Prepaids and other current assets
0.6

Property, plant, and equipment
21.4

Other assets, non-current
2.0

Intangibles
81.1

Goodwill
168.8

Total assets acquired
328.7

 
 
Current liabilities
(17.9
)
Other liabilities, non-current
(37.5
)
Total liabilities assumed
(55.4
)
Net assets acquired
$
273.3

The fair value assigned to goodwill is attributable to expected cost synergy opportunities. Included in the goodwill recorded for the PKI Imaging acquisition is approximately $35 million that will be deductible for income tax purposes in Germany, China and the Netherlands. The remaining goodwill related to the stock acquisition in the United States is not tax deductible. Also, as a result of the acquisition, non-current deferred income tax liability increased by approximately $31 million related to basis differences for both tangible and intangible assets acquired as part of the stock purchases in the United States and the United Kingdom, and asset purchases in Germany, the Netherlands and China.
The following amounts represent the determination of the fair value of identifiable intangible assets for PKI Imaging, which are amortized straight-line:
(In millions)
Fair Value
 
Estimated
Useful Life
(In Years)
Favorable leasehold interests
$
3.8

 
6
Backlog
1.2

 
1
Trade names
1.4

 
5
Developed technology
37.7

 
7
IPR&D
4.0

 
indefinite
Customer relationships
33.0

 
7
Total intangible assets acquired
$
81.1

 
 
The following amounts represent revenues by reporting segment from PKI Imaging from the acquisition date of May 1, 2017 through June 30, 2017:
 
May 1, 2017 through June 30, 2017
(In millions)
PKI Imaging business revenues
 
Medical
$
17.7

Industrial
9.0

Total PKI Imaging business revenues
$
26.7


14




Unaudited Pro Forma Information
The unaudited pro-forma amounts presented below for the nine months ended June 30, 2017 and nine months ended July 1, 2016 are presented for informational purposes only. In addition to the Company's results for the periods presented, the amounts below also include effects of the PKI Imaging acquisition as if it had been consummated on October 3, 2015. Audited results for the PKI Imaging acquisition for the fiscal years ended 2016 and 2015 are noted in the Company’s Form 8-K/A filed with the SEC on July 7, 2017.
These unaudited pro-forma results include effects that are directly attributable to the acquisition which include the amortization of intangible assets, interest expense, and other adjustments, including estimated tax effects. The unaudited pro-forma results do not reflect any operating efficiencies or potential cost savings which may result from the integration of the PKI Imaging acquisition and are not necessarily indicative of what the actual results of operations of the combined company would have been if the acquisition had occurred at the beginning of the period presented nor are they indicative of future results of operations or results that might have been achieved had the acquisition been consummated as of October 3, 2015.
 
Nine Months Ended
(In millions)
June 30, 2017
 
July 1, 2016
Revenue
$
562.1

 
$
563.6

Operating earnings
$
64.2

 
$
95.8

Net earnings
$
35.9

 
$
54.9

Net earnings per share, basic
$
0.96

 
$
1.47

Net earnings per share, diluted
$
0.95

 
$
1.46

5. RELATED-PARTY TRANSACTIONS
Transactions with Varian Medical Systems, Inc.
During the three months ended June 30, 2017 and July 1, 2016, the Company recorded sales to Varian of $6.4 million and $4.7 million, respectively, and recorded purchases of products from Varian of $0.5 million and $0.5 million, respectively. During the nine months ended June 30, 2017 and July 1, 2016, the Company recorded sales to Varian of $19.2 million and $16.2 million, respectively, and recorded purchases of products from Varian of $1.4 million and $1.5 million, respectively.
Allocated Costs
Prior to the separation on January 28, 2017, the condensed consolidated financial statements include allocations of corporate expenses from Varian to the Company. These allocated expenses include costs of information technology, human resources, accounting, legal, facilities, insurance, treasury and other corporate and infrastructure services. Allocated costs also include research and development expenses from Varian’s scientific research facility. These costs have been allocated to the Company on the basis of direct usage when identifiable or other systematic measures that reflect utilization of services provided to or benefits received by the Company. The Company considers the expense allocation methodology and results to be reasonable for all periods presented.
Allocated costs included in the accompanying condensed consolidated statements of earnings are as follows:

Three Months Ended
 
Nine Months Ended
(In millions)
June 30, 2017
 
July 1, 2016
 
June 30, 2017
 
July 1, 2016
Selling, general and administrative
$

 
$
8.6

 
$
12.4


$
28.2

Research and development

 
0.4

 


0.9

Interest expense, net of interest income

 
0.3

 
0.5

 
0.9

Net Parent Investment
In conjunction with the separation, net parent company investment in the condensed consolidated balance sheets and condensed consolidated statements of equity was converted into Varex common stock.
In accordance with the Separation and Distribution Agreement, the Company transferred $27.1 million to Varian during the three months ended June 30, 2017, which represented all cash and cash equivalents in excess of $5 million, other than any cash and cash equivalents held by MeVis Medical Solutions AG (“MeVis”) and any Varex entities needed in order to complete the transfer of

15


certain assets and subsidiaries from Varian. Funds held to complete these asset and subsidiary transfers was approximately $18.6 million as of June 30, 2017 and is included in accrued liabilities.
Equity Method Investment
The Company has a 40% ownership interest in dpiX Holding LLC (“dPix Holding”), a four-member consortium that has a 100% ownership interest in dpiX LLC (“dpiX”), a supplier of amorphous silicon based thin film transistor arrays for digital flat panel image detectors. In accordance with the dpiX Holding Agreement, net profits or losses are allocated to the members, in accordance with their ownership interests.
The equity investment in dpiX Holding is accounted for under the equity method of accounting. When the Company recognizes its share of net profits or losses of dpiX Holding, profits or losses in inventory purchased from dpiX are eliminated until realized by the Company. During the three months ended June 30, 2017 and July 1, 2016, the Company recorded income and (loss) on the equity investment in dpiX Holding of $2.3 million and $(0.8) million, respectively. During the nine months ended June 30, 2017 and July 1, 2016, the Company recorded income and (loss) on the equity investment in dpiX Holding of $2.9 million and $(0.9) million, respectively. Income and loss on the equity investment in dpiX Holding is included in other income (expense), net in the condensed consolidated statements of earnings. The carrying value of the equity investment in dpiX Holding, which was included in investments in privately-held companies on the condensed consolidated balance sheets, was $50.0 million and $47.2 million at June 30, 2017 and September 30, 2016, respectively.
During the three months ended June 30, 2017 and July 1, 2016, the Company purchased glass transistor arrays from dpiX totaling $5.3 million and $6.4 million, respectively. During the nine months ended June 30, 2017 and July 1, 2016, the Company purchased glass transistor arrays from dpiX totaling $10.9 million and $16.8 million, respectively. These purchases of glass transistor arrays are included as a component of inventories on the condensed consolidated balance sheets or cost of revenues—product in the condensed consolidated statements of earnings for these fiscal years.
As of June 30, 2017 and September 30, 2016, the Company had accounts payable to dpiX totaling $5.0 million and $4.2 million, respectively.
In October 2013, the Company entered into an amended agreement with dpiX and other parties that, among other things, provides the Company with the right to 50% of dpiX’s total manufacturing capacity produced after January 1, 2014. The amended agreement requires the Company to pay for 50% of the fixed costs (as defined in the amended agreement), as determined at the beginning of each calendar year. As of June 30, 2017, the Company estimated it has fixed cost commitments of $8.1 million related to this amended agreement through the remainder of fiscal year 2017. The fixed cost commitment for future periods will be determined and approved by the dpiX board of directors at the beginning of each calendar year. The amended agreement will continue unless the ownership structure of dpiX changes (as defined in the amended agreement).
 
The Company has determined that dpiX is a variable interest entity because at-risk equity holders, as a group, lack the characteristics of a controlling financial interest. Majority votes are required to direct the manufacturing activities, legal operations and other activities that most significantly affect dpiX’s economic performance. The Company does not have majority voting rights and no power to direct the activities of dpiX and therefore is not the primary beneficiary of dpiX. The Company’s exposure to loss as a result of its involvement with dpiX is limited to the carrying value of the Company’s investment and fixed cost commitments.
6. CONCENTRATION OF CREDIT RISK

Credit is extended to customers based on an evaluation of the customer’s financial condition, and collateral is not required. During the periods presented, one customer accounted for a significant portion of revenues, which are as follows:

Three Months Ended
 
Nine Months Ended

June 30, 2017
 
July 1, 2016
 
June 30, 2017
 
July 1, 2016
Revenues to Toshiba Medical Systems
18.8%

24.6%
 
20.5%
 
22.8%

Toshiba Medical Systems accounted for 11.5% and 13.0% of the Company’s accounts receivable as of June 30, 2017 and September 30, 2016, respectively.

16


7. FINANCIAL DERIVATIVES AND HEDGING ACTIVITIES

As part of the Company’s overall risk management practices, the Company enters into financial derivatives, which include interest rate swaps designed as cash flow hedges, to hedge the LIBOR-based, floating interest rate on its debt.
The Company records all derivatives on the consolidated balance sheets at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting, and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting.
The effective portion of the gain or loss on derivative instruments designated and qualifying for cash flow hedge accounting is deferred in other comprehensive income. Any ineffectiveness in these designated hedging relationships is recognized in current period earnings. The changes in fair value for all trades that are not designated for hedge accounting are recognized in current period earnings. Deferred gains or losses from designated cash flow hedges are reclassified into earnings in the period that the hedged interest expense effect earnings. The effectiveness of cash flow hedges is assessed at inception and quarterly thereafter. If the instrument were to no longer qualify for hedge accounting due to it becoming probable that the originally-forecasted hedged transactions will not occur, then hedge accounting would cease and the related change in fair value of the ineffective portion of the derivative instrument would be reclassified from accumulated other comprehensive income (loss) and recognized in earnings. The Company does not offset fair value amounts recognized for derivative instruments in its balance sheet for presentation purposes.
Credit risk related to derivative transactions reflects the risk that a party to the transaction could fail to meet its obligation under the derivative contracts. Therefore, the Company’s exposure to the counterparty’s credit risk is generally limited to the amounts, if any, by which the counterparty’s obligations to the Company exceed the Company’s obligations to the counterparty. The Company’s policy is to enter into contracts only with financial institutions which meet certain minimum credit ratings to help mitigate counterparty credit risk.
Derivatives Designated as Hedging Instruments - Cash Flow Hedges
The Company uses interest rate swap contracts as cash flow hedges to manage its exposure to fluctuations in LIBOR interest rates. Interest rate swap contracts hedging variable rate debt effectively fix the LIBOR component of its interest rate for a specific period of time.
The effective portion of changes in the fair value of derivatives designated and qualifying as cash flow hedges is deferred as a component of accumulated other comprehensive income in the accompanying consolidated balance sheets and is subsequently reclassified into earnings in the period that the hedged interest expense effects earnings. The ineffective portion of the changes in fair value of derivatives designated as cash flow hedges are recognized directly to earnings and reflected in the accompanying condensed consolidated statements of earnings. No ineffectiveness was reported in earnings for the period ending June 30, 2017.
As of June 30, 2017, the Company had the following outstanding derivatives designated as hedging instruments:
(In millions, except for number of instruments)
 
Number of Instruments
 
Notional Value
Interest Rate Swap Contracts
 
6

 
$
296.3


These contracts have maturities of four years or less.
The following table summarizes the amount of income recognized from derivative instruments for the periods indicated and the line items in the accompanying statements of operations where the results are recorded for cash flow hedges:

17


 
Amount of Gain (Loss) Recognized in OCI on Derivative (Effective Portion) Three months ended
 
Location of Gain or (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)
 
Amount of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) Three months ended
 
Location of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion)
 
Amount of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion)
Three months ended
(In millions)
June 30, 2017
 
July 1, 2016
 
 
June 30, 2017
 
July 1, 2016
 
 
June 30, 2017
 
July 1, 2016
Interest Rate Swap Contracts
$
0.6

 
$

 
Interest expense
 
$

 
$

 
Interest expense
 
$

 
$

    
The Company expects that approximately $(1.0) recorded as a component of accumulated other comprehensive income (loss) will be realized in the statements of earnings over the next 12 months and the amount will vary depending on interest rates.
These derivative instruments are subject to master netting agreements giving effect to rights of offset with each counterparty. The following table summarizes the fair values of derivative instruments as of the periods indicated and the line items in the accompanying consolidated balance sheets where the instruments are recorded:
 
 
Derivative Assets
 
Derivative Liabilities
(In millions)
 
 
 
June 30, 2017
 
September 30, 2016
 
 
 
June 30, 2017
 
September 30, 2016
Derivatives designated as cash flow hedges
 
Balance sheet location
 
 
 
 
 
Balance sheet location
 
 
 
 
Interest rate swap contracts
 
Other non-current assets
 
$
1.6

 
$

 
Other non-current assets
 
$

 
$

Interest rate swap contracts
 
Other current liabilities
 

 

 
Other current liabilities
 
(1.0
)
 

 
 
 
 
$
1.6

 
$

 
 
 
$
(1.0
)
 
$

8. FAIR VALUE
Assets/Liabilities Measured at Fair Value on a Recurring Basis
In the tables below, the Company has segregated all assets and liabilities that are measured at fair value on a recurring basis into the most appropriate level within the fair value hierarchy based on the inputs used to determine the fair value at the measurement date.
 
(In millions)
Fair Value Measurements at June 30, 2017

Quoted Prices in Active Markets for Identical Assets and Liabilities
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
Total
Assets:
 
 
 
 
 
 
 
Cash equivalents - Money market funds
$
10.6

 
$

 
$

 
$
10.6

Interest rate swap contracts

 
1.6

 

 
1.6

Total assets measured at fair value
$
10.6

 
$
1.6

 
$

 
$
12.2

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Interest rate swap contracts
$

 
$
1.0

 
$

 
$
1.0

As of June 30, 2017, the outstanding borrowings under the Company's credit agreement were $498.7 million, net of deferred loan costs, which approximated its fair value. The fair values of certain of the Company’s financial instruments, including bank deposits included in cash and cash equivalents, accounts receivable and accounts payable, also approximate their fair values due to their short maturities.
At September 30, 2016, the Company did not have any assets or liabilities measured at fair value on a recurring basis.
There were no financial assets or liabilities measured on a recurring basis using significant unobservable inputs (Level 3) and there were no transfers in or out of Level 1, 2 or 3 during the three and nine months ended June 30, 2017.
9. INVENTORY, NET
The following table summarizes the Company’s inventories, net:
(In millions)
June 30, 2017
 
September 30, 2016
Raw materials and parts, net
$
189.9


$
150.0

Work-in-process, net
15.6


7.2

Finished goods, net
50.8


40.2

Total inventories, net
$
256.3


$
197.4


Total inventories, net at June 30, 2017 includes approximately $31.7 million of inventories, net related to the acquired PKI Imaging business.
10. GOODWILL AND INTANGIBLE ASSETS
The following table reflects goodwill by reportable operating segment:
(In millions)
Medical

Industrial

Total
Balance at September 30, 2016
$
55.7

 
$
19.0

 
$
74.7

Business combinations - PerkinElmer Medical Imaging Business
92.3

 
76.5

 
168.8

Disposition of business
(0.2
)
 
 
 
(0.2
)
Balance at June 30, 2017
$
147.8

 
$
95.5

 
$
243.3

In the fourth quarter of fiscal year 2016, the Company realigned its segments and goodwill was re-allocated to the Medical and Industrial reporting units based on their relative fair values. There were no impairment charges recognized as a result of the change in reporting units between September 30, 2016 and June 30, 2017.

18


The following table reflects the gross carrying amount and accumulated amortization of the Company’s finite-lived intangible assets included in other assets in the condensed consolidated balance sheets:
(In millions)
June 30, 2017
 
September 30, 2016
Acquired existing technology
$
61.0


$
19.5

Patents, licenses and other
19.4


9.8

Customer contracts and supplier relationship
42.1


9.4

Accumulated amortization
(27.0
)

(18.0
)
Net carrying amount
$
95.5


$
20.7

Amortization expense for intangible assets was $3.4 million and $1.2 million for the three months ended June 30, 2017 and July 1, 2016, respectively, and $6.2 million and $4.2 million for the nine months ended June 30, 2017 and July 1, 2016, respectively.
11. COMMITMENTS AND CONTINGENCIES
Product Warranty
The following table reflects the changes in the Company’s accrued product warranty:
(In millions)
Warranty Allowance
Accrued product warranty, September 30, 2016
$
6.9

Product warranty for PKI Imaging
1.2

Charged to cost of revenues
7.6

Actual product warranty expenditures
(8.9
)
Accrued product warranty, June 30, 2017
$
6.8

Other Commitments
See Note 5, “Related Party Transactions” for additional information about the Company’s commitments to dpiX.
See Note 13, “Noncontrolling Interests” for additional information about the Company’s commitment to the noncontrolling shareholders of MeVis.
 Contingencies
From time to time, the Company is a party to or otherwise involved in legal proceedings, claims and government inspections or investigations and other legal matters, both inside and outside the United States, arising in the ordinary course of its business or otherwise. The Company accrues amounts, 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 contingent liabilities as of June 30, 2017 and September 30, 2016. Legal expenses are expensed as incurred.
12. BORROWINGS

Credit Facility
On January 25, 2017, the Company entered into a revolving credit facility (the "Previous Revolving Credit Facility"), which matured in five years, and a term facility (the "Previous Term Facility"), which was to be repaid over five years, with 7.5% payable in quarterly installments during the first two years, 10% payable in quarterly installments during the third and fourth years and 15% payable in quarterly installments in the fifth year. The credit agreement relating to the Previous Revolving Credit Facility and the

19


Previous Term Facility (the “Previous Credit Agreement”) contained various customary restrictive covenants that limited, among other things, the incurrence of indebtedness by Varex and its subsidiaries, the grant or incurrence of liens by Varex and its subsidiaries, the entry into sale and leaseback transactions by Varex and its subsidiaries, and the entry into certain fundamental change transactions by Varex and its subsidiaries. It also contained customary events of default and certain financial covenants, including the requirement to maintain certain financial ratios. The Previous Credit Agreement was secured by the stock and assets of certain Varex subsidiaries. The Previous Credit Agreement had several borrowing and interest rate options including the following indices: (i) the LIBOR rate, or (ii) the base rate (equal to the greater of the prime rate, the federal funds rate plus 0.50% or the LIBOR rate for a one-month period plus 1.00%). Loans under the Previous Credit Agreement bore interest at a rate per annum using the applicable indices plus a varying interest rate margin of between 1.125% and 2.125%. The Previous Credit Agreement also provided for fees applicable to amounts available to be drawn under outstanding letters of credit of 0.125% and a fee on unused commitments which ranges from 0.20% to 0.40%. On January 25, 2017, Varex borrowed $203 million under Previous Term Facility and transferred $200.0 million to Varian.
On May 1, 2017 and in connection with the acquisition of PKI Imaging, Varex entered into a new secured revolving credit facility (the "Revolving Credit Facility") in an aggregate principal amount of up to $200 million with a five-year term, and a secured term facility (the "Term Facility" and together with the Revolving Credit Facility, the "Credit Agreement") in an aggregate principal amount of $400 million. The Term Facility will be repaid over five years, with 5.0% payable in quarterly installments during each of the first two years of the term thereof, 7.5% payable in quarterly installments during the third and fourth years of the term thereof, and 10% payable in quarterly installments in the fifth year of the term thereof, with the remaining amount due at maturity. Varex used the net proceeds from the Term Facility, and the net proceeds from approximately $97 million drawn on the Revolving Credit Facility, to pay the approximately $276 million purchase price for the acquisition of PKI Imaging, plus related credit facility fees, and to repay all of Varex’s obligations under the Previous Credit Agreement.
The Credit Agreement contains various customary restrictive covenants that limits, among other things, the incurrence of indebtedness by Varex and its subsidiaries, the grant or incurrence of liens by Varex and its subsidiaries, the entry into sale and leaseback transactions by Varex and its subsidiaries, and the entry into certain fundamental change transactions by Varex and its subsidiaries. It also contains customary events of default and certain financial covenants, including the requirement to maintain certain financial ratios. The Credit Agreement is secured by the stock and assets of Varex’s material subsidiaries. The Credit Agreement has several borrowing and interest rate options including the following indices: (a) LIBOR rate, or (b) the base rate (equal to the greater of the prime rate, the federal funds rate plus 0.50% or the LIBOR rate for a one-month period plus 1.00%). Loans under the Credit Agreement bear interest at a rate per annum using the applicable indices plus a varying interest rate margin of between 1.75% and 2.75% (for LIBOR rate loans) and 0.75%-1.75% (for base rate loans). The Credit Agreement also provides for fees applicable to amounts available to be drawn under outstanding letters of credit of 0.125%, and a fee on unused commitments which ranges from 0.25% to 0.40%.    
At June 30, 2017, the Company had $478.7 million in long-term debt outstanding and $20.0 million of current maturities of long-term debt outstanding, net of deferred issuance costs of $11.3 million.
13. REDEEMABLE NONCONTROLLING INTERESTS
In April 2015, the Company completed the acquisition of 73.5% of the then outstanding shares of MeVis, a public company based in Bremen, Germany that provides image processing software and services for cancer screening.
 
In August 2015, the Company, through one of its German subsidiaries, entered into a Domination and Profit and Loss Transfer Agreement (the “DPLTA”) with MeVis. In October 2015, the DPLTA became effective upon its registration at the local court of Bremen, Germany. Under the DPLTA, MeVis subordinates its management to the Company and undertakes to transfer all of its annual profits and losses to the Company. In return, the DPLTA grants the noncontrolling shareholders of MeVis: (1) an annual recurring net compensation of €0.95 per MeVis share starting from January 1, 2015; and, (2) a put right for their MeVis shares at €19.77 per MeVis share. Upon effectiveness of the DPLTA, the noncontrolling interests in MeVis became redeemable as a result of the put right and were reclassified to temporary equity.

Changes in redeemable noncontrolling interests relating to MeVis were as follows:

20


 
Nine Months Ended
(In millions)
June 30, 2017
Balance at beginning of period
$
10.3

Net earnings attributable to noncontrolling interests
0.2

Other
(0.2
)
Balance at end of period
$
10.3

During the three months ended June 30, 2017, the Company purchased an immaterial number of MeVis’ shares under the put right. At June 30, 2017, noncontrolling shareholders together held approximately 0.5 million shares of MeVis, representing 26.3% of the outstanding shares.
14. NET EARNINGS PER SHARE
Basic net earnings per common share is computed by dividing the net earnings for the period by the weighted average number of shares of common stock outstanding during the reporting period. Diluted net earnings per common share reflects the effects of potentially dilutive securities, which is computed by dividing net earnings by the sum of the weighted average number of common shares outstanding and dilutive common shares, which consists stock options and unvested restricted stock.
A reconciliation of the numerator and denominator used in the calculation of basic and diluted net income per common share is as follows:
 
Three Months Ended
 
Nine Months Ended
(In millions, except per share amounts)
June 30, 2017
 
July 1, 2016(1)
 
June 30, 2017(2)
 
July 1, 2016(1)
Net earnings attributable to Varex
$
10.6

 
$
17.6

 
$
36.8

 
$
46.5

Weighted average shares outstanding - basic
37.6

 
37.4

 
37.5

 
37.4

Dilutive effect of potential common shares
0.4

 
0.3

 
0.4

 
0.3

Weighted average shares outstanding - diluted
38

 
37.7

 
37.9

 
37.7

Net earnings per share attributable to Varex - basic
$
0.28

 
$
0.47

 
$
0.98

 
$
1.24

Net earnings per share attributable to Varex - diluted
$
0.28

 
$
0.47

 
$
0.97

 
$
1.23

Anti-dilutive employee shared based awards, excluded
1.0

 
0.7

 
1.0

 
0.7

(1) Basic and diluted net earnings for the three and nine months ended July 1, 2016 is calculated using the number of common shares distributed on January 28, 2017.
(2) Basic and diluted net income per share for the nine months ended June 30, 2017 is calculated using the weighted average number of common shares outstanding for the period beginning after the distribution date.
The Company excludes potentially dilutive common shares (consisting of shares underlying stock options and the employee stock purchase plan) from the computation of diluted weighted average shares outstanding if the inclusion of the shares underlying these stock awards would be anti-dilutive to earnings per share.
15. EMPLOYEE STOCK PLANS
Employee Stock Plans
Prior to the separation and distribution, the Company’s employees participated in Varian's stock-based compensation plans, which provided for the grants of stock options, restricted stock units and performance shares among other types of awards under Varian’s Third Amended and Restated 2005 Omnibus 2005 Stock Plan (the “Third Amended 2005 Plan”). The expense associated with the Company’s employees who participated in the Third Amended 2005 Plan is included in the accompanying condensed consolidated statements of earnings. Subsequent to the separation and distribution, the Company's employees participate in Varex's 2017 Omnibus Stock Plan and 2017 Employee Stock Purchase Plan.
Share-Based Compensation Expense

21


As share-based compensation expense recognized in the condensed consolidated statements of earnings is based on awards ultimately expected to vest. Share-based compensation expense includes expenses related to the Company’s direct employees. Prior to the separation, Varian also charged the Company for the allocated share-based compensation costs of certain employees of Varian who provided selling, general and administrative services on the Company’s behalf.
The table below summarizes the effect of recording share-based compensation expense and for the option component of the employee stock purchase plan shares:

Three Months Ended
 
Nine Months Ended
(In millions)
June 30, 2017
 
July 1, 2016
 
June 30, 2017
 
July 1, 2016
Cost of revenues
$
0.4

 
$
0.2

 
$
0.7

 
$
0.7

Research and development
0.4

 
0.4

 
3.5

 
1.0

Selling, general and administrative (1)
1.7

 
1.8

 
1.9

 
5.3

Total share-based compensation expense
$
2.5

 
$
2.4

 
$
6.1

 
$
7.0


(1) Includes allocated share-based compensation of $0 million and $0.8 million for the three and nine months ended June 30, 2017, respectively, and $0.8 million and $2.5 million for the three and nine months ended July 1, 2016, respectively, charged by Varian to the Company for certain Varian employees who provided general and administrative services on the Company’s behalf.
Stock Option Activity
The following table summarizes the activity for stock options under Varex’s employee incentive plans for the Company’s employees:
 
Options Outstanding
(In thousands, except per share amounts and the remaining term)
Number of Shares
 
Weighted Average
Exercise Price
 
Weighted Average Remaining Term (in years)
 
Aggregate Intrinsic Value (2)
Balance at September 30, 2016 (1)
1,015

 
$
26.14

 
 
 
 
Granted
1,052

 
31.2

 
 
 
 
Canceled, expired or forfeited
(17
)
 
27.85

 
 
 
 
Exercised
(122
)
 
22.6

 
 
 
 
Balance at June 30, 2017
1,928

 
$
29.11

 
5.5
 
$
9,057

 
 
 
 
 
 
 
 
Exercisable at June 30, 2017
670

 
$
26.70

 
3.8
 
$
4,758

(1) The outstanding options at September 30, 2016 represent outstanding options after converting such awards in accordance with the Employee Matters Agreement filed as Exhibit 10.3 to the Company's Form 10 filed with the SEC on January 12, 2017.
(2) The aggregate intrinsic value represents the total pre-tax intrinsic value, which is computed based on the difference between the exercise price and the closing price of Varex common stock of $33.80 as of June 30, 2017, the last trading date of the Company's third quarter, and which represents the amount that would have been received by the option holders had all option holders exercised their options and sold the shares received upon exercise as of that date.
Restricted Stock Units
The following table summarizes the activity for restricted stock units under Varex’s employee incentive plans for the Company’s employees:

22


(In thousands, except per share amounts)
Number of Shares

Weighted Average
Grant-Date Fair
Value
Balance at September 30, 2016 (1)
385


$
27.42

Granted
334


31.33

Vested
(185
)

27.84

Canceled or expired
(9
)

26.71

Balance at June 30, 2017
525


$
29.77

(1) The outstanding RSUs at September 30, 2016 represent outstanding units after converting such units in accordance with the Employee Matters Agreement filed as Exhibit 10.3 to the Company's Form 10 filed with the SEC on January 12, 2017.
16. TAXES ON EARNINGS
The Company recognized income tax expense of $5.1 million and $9.3 million for the three months ended June 30, 2017 and July 1, 2016, respectively, for effective rates of 32.3% and 34.3%, respectively, computed using an estimated effective rate method based on forecasted earnings. The estimated effective rate for the current year is lower due to a difference in the mix of forecasted earnings by jurisdiction and overall global tax structure for Varex as a stand-alone company compared to the prior year when it was part of Varian.
The Company recognized income tax expense of $19.6 million and $26.4 million for the nine months ended June 30, 2017 and July 1, 2016, respectively, for effective rates of 34.6% and 36.1%, respectively, computed using an estimated effective rate method based on forecasted earnings. The reduction in the estimated effective rate for the current year results from the difference in the mix of forecasted earnings by jurisdiction and overall global tax structure for Varex as a stand-alone company compared to the prior year when it was part of Varian.
These effective rates differ from the statutory rate of 35% primarily as a result of U.S. state income taxes and losses in foreign jurisdictions for which no benefit is recorded due to valuation allowance positions partially offset by earnings in other foreign jurisdictions taxed at lower rates and U.S. domestic production activities deduction and research and development credits.
As noted in the previous description of the PKI Imaging acquisition in Note 4, "Business Combinations" the Company recorded an incremental non-current deferred tax liability of approximately $31 million related to basis differences for both tangible and intangible assets acquired as part of the stock purchases in the United States and the United Kingdom, and assets purchases in Germany, the Netherlands and China.
17. SEGMENT INFORMATION
As part of the Company's transition to a stand-alone company, the Company’s Chief Executive Officer, who is also its Chief Operating Decision maker (“CODM”), re-evaluated the product groupings and how he views and measures the business performance, and, therefore, subsequent to the filing of the preliminary registration statement on Form 10 on August 11, 2016, the Company reorganized its two reportable operating segments into Medical and Industrial. The realigned segments better align the Company’s 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. The new operating and reportable segment structure provides better visibility and clarity into the financial performance of the Company’s products, as well as an alignment between business strategies and operating results.
 
Description of Segments
The Medical segment designs, manufactures, sells and services X-ray imaging components for use in a range of applications, including radiographic or fluoroscopic imaging, mammography, special procedures, computed tomography, radiation therapy and computer-aided detection. The Company provides 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, ionization chambers and buckys. The Company’s X-ray imaging components are primarily sold to imaging system OEM customers that incorporate them into their medical diagnostic, radiation therapy, dental, veterinary and industrial imaging systems. The Company also sells its X-ray imaging components to independent service companies, distributors and directly to end-users for replacement purposes.

23


The Industrial segment designs, manufactures, sells and services security and inspection products, which include Linatron X-ray accelerators, X-ray tubes, digital detectors, high voltage connectors, image processing software and image detection products for security and inspection purposes, such as cargo screening at ports and borders and nondestructive examination in a variety of applications. The Company generally sells its Industrial products to OEM customers that incorporate its products into their inspection systems.
Accordingly, the following information is provided for purposes of achieving an understanding of operations, but it may not be indicative of the financial results of the reported segments were they independent organizations. In addition, comparisons of the Company’s operations to similar operations of other companies may not be meaningful.
Information related to the Company’s segments is as follows:

Three Months Ended
 
Nine Months Ended
(In millions)
June 30, 2017
 
July 1, 2016
 
June 30, 2017
 
July 1, 2016
Revenues
 
 
 
 
 
 
 
Medical
$
134.7

 
$
125.9

 
$
392.1


$
370.8

Industrial
35.4

 
25.5

 
90.3


77.2

Total revenues
$
170.1

 
$
151.4

 
$
482.4


$
448.0

Gross margin
 
 
 
 
 
 
 
Medical
$
45.3

 
$
52.1

 
$
136.9

 
$
144.8

Industrial
14.2

 
10.9

 
38.9

 
34.4

Total gross margin
$
59.5

 
$
63.0

 
$
175.8

 
$
179.2

Geographic Revenues
 
Three Months Ended
 
Nine Months Ended
(In millions)
June 30, 2017
 
July 1, 2016
 
June 30, 2017
 
July 1, 2016
Americas
$
61.7

 
$
48.4

 
$
159.7

 
$
161.6

EMEA
54.1

 
43.8

 
150.2

 
132.9

APAC
54.3

 
59.2

 
172.5

 
153.5

Total revenues
$
170.1

 
$
151.4

 
$
482.4

 
$
448.0

The Company operates various manufacturing and marketing operations outside the United States. Allocation between domestic and foreign revenues is based on known final destination of products sold.
The following table summarizes the Company’s total assets by its reportable segments:
(In millions)
June 30, 2017
 
September 30, 2016
Identifiable assets
 
 
 
Medical
$
847.7


$
481.4

Industrial
198.8


134.7

Total reportable segments
$
1,046.5


$
616.1

Unallocated corporate assets


6.3

Total combined assets
$
1,046.5


$
622.4



24


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 Form 10 filed with the Securities and Exchange Commission on January 12, 2017, for the fiscal years ended 2016, 2015 and 2014.
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 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 this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (“MD&A”), the Risk Factors listed under Part II, Item 1A of this Quarterly Report 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 flat panel 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.
Separation and Distribution
On January 28, 2017, 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 shares distributed to Varian shareholders.
A summary of certain material features of the agreements can be found in the section entitled “Relationships with Varian Following Separation and Distribution” in Varex's Information Statement dated January 20, 2017 (the “Information Statement”), which was included as Exhibit 99.1 to Varex’s Current Report on 8-K filed with the Securities and Exchange Commission on January 20, 2017.
Overview
Varex Imaging Corporation is a leading innovator, designer and manufacturer of X-ray imaging components, which include tubes, digital flat panel detectors and other image processing solutions, which are key components of X-ray imaging systems. 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. Varex has approximately 1,900 full-time equivalents employees, located at manufacturing and service center sites in North America, Europe, and Asia. For more information about Varex, visit vareximaging.com.
On May 1, 2017, we acquired the Medical Imaging business of PerkinElmer, Inc. for net cash consideration of $271.8 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 X-ray detectors that serve as components for industrial, medical, dental and veterinary X-ray imaging systems. PKI Imaging has about 280 employees, is headquartered in Santa Clara, California and has additional operations in Germany, the Netherlands and the United Kingdom. We believe the acquisition complements our existing imaging detector business and will provide increased expertise and opportunities for Varex in the future.
Our products are sold in three geographic regions: The Americas, EMEA, and APAC. The Americas includes North America (primarily 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. A significant portion of our customers are outside of the United States, and products in this business are generally priced in U.S. Dollars. Demand for our products can be negatively impacted by the strengthening of the U.S. Dollar, and can cause our products to be priced higher compared to products sold in non-U.S. Dollar currencies. We are continuing to have some

25


customers ask for additional discounts, delay purchasing decisions, or move to in-sourcing supply of such components or migrate to lower cost alternatives. The market for border protection systems has stabilized; however, end customers, particularly in oil-based economies and war zones in which we have a significant customer base, continue to delay tenders, resulting in reduced demand for security products.
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.
Medical
In our Medical business segment, we design, manufacture, sell and service X-ray imaging components for use in a range of applications, including radiographic or fluoroscopic imaging, mammography, special procedures, 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, flat panel digital 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 detector market continues to mature from initial product introductions approximately 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.
Industrial
In our Industrial business segment, we design, manufacture, sell and service products for use in security and industrial inspection applications, such as cargo screening at ports and borders and nondestructive examination in a variety of applications. The products include Linatron X-ray accelerators, X-ray tubes, digital detectors, high voltage connectors, image-processing software and image detection products that we generally sell to OEM customers that incorporate these products into their inspection systems.
Basis of Presentation
Prior to the separation and distribution, our historical condensed consolidated financial statements have been prepared on a stand-alone basis and were derived from Varian’s consolidated financial statements and records as we operated as part of Varian. Following the separation and distribution, the condensed consolidated financial statements reflect our financial position, results of operations, comprehensive earnings and cash flows in conformity with U.S. generally accepted accounting principles (“GAAP”).
For periods prior to the separation and distribution, the condensed consolidated financial statements include allocation of certain Varian corporate expenses including costs of information technology, human resources, accounting, legal, facilities, insurance, treasury and other corporate and infrastructure services. In addition, allocated costs include research and development expenses from Varian’s scientific research facility. These costs were allocated to us on the basis of direct usage when identifiable or other systematic measures that reflect utilization of services provided to or benefits received. We consider the expense allocation methodology and results to be reasonable for all periods presented. The condensed consolidated financial statements also include certain assets and liabilities that have historically been held at the Varian corporate level, but which are specifically identifiable and attributable to us. Our condensed consolidated financial position, results of operations, comprehensive earnings and cash flows prior to the separation

26


may not be indicative of our results had we been a separate stand-alone entity during the periods presented, nor are the results stated herein indicative of what our financial position, results of operations, comprehensive earnings, and cash flows may be in the future.
Cash and cash equivalents held by Varian were not allocated to us. Cash and cash equivalents included in the condensed consolidated balance sheets primarily reflects cash and cash equivalents from acquired entities that are specifically attributable to us. Varian’s debt has not been allocated to us for any of the periods presented since we are not the legal obligor of the debt. Varian’s debt was utilized for corporate activities that benefited all businesses and therefore a portion of the interest expense relating to Varian’s corporate borrowings has been allocated to us. Interest expense and interest income has been allocated based on our total assets as a percentage of total assets of Varian.
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. For a discussion of how these estimates and other factors may affect our business, see “Risk Factors.”
We periodically review our accounting policies, estimates and assumptions and make adjustments when facts and circumstances dictate. Refer to our Registration Statement on Form 10, which was filed with the Securities and Exchange Commission on January 12, 2017 for our critical accounting policies and Note 3, “Summary of Significant Accounting Policies” for further details.
Fiscal Year
Our fiscal year is a 52 or 53-week period ending on the Friday nearest September 30. Fiscal year 2016 was a 52-week period that ended on September 30, 2016. The fiscal quarters ended June 30, 2017 and July 1, 2016 were both 13-week periods.
Discussion of Results of Operations for the Three Months Ended June 30, 2017 Compared to the Three Months Ended July 1, 2016

Revenues
 
Three Months Ended
 
 
 
 
(In millions)
June 30, 2017
 
July 1, 2016
 
$ Change
 
% Change
Medical
$
134.7

 
$
125.9

 
$
8.8

 
7.0
%
Industrial
35.4

 
25.5

 
9.9

 
38.8
%
Total revenues
$
170.1

 
$
151.4

 
$
18.7

 
12.4
%
Medical as a percentage of total revenues
79
%
 
83
%
 
 
 
 
Industrial as a percentage of total revenues
21
%
 
17
%
 
 
 
 
Medical revenues increased by $8.8 million primarily due to $17.7 million in revenue from the acquired PKI Imaging business offset by a decrease in non-acquisition Medical revenues due to lower sales of X-ray tubes to APAC and lower digital detector sales. Industrial revenues increased $9.9 million due to $9.0 million in revenue from the acquired PKI Imaging business and an increase in non-acquisition Industrial revenue related to higher service and linear accelerator revenues for our security products, along with an increase in sales of industrial X-ray tubes. These increases in Industrial revenues were partially offset by a decrease in revenue from non-acquisition industrial detectors.

27


Revenues by Region
 
Three Months Ended
 
 
 
 
(In millions)
June 30, 2017
 
July 1, 2016
 
$ Change
 
% Change
Americas
$
61.7

 
$
48.4

 
$
13.3

 
27.5
 %
EMEA
54.1

 
43.8

 
10.3

 
23.5
 %
APAC
54.3

 
59.2

 
(4.9
)
 
(8.3
)%
Total revenues
$
170.1

 
$
151.4

 
$
18.7

 
12.4
 %
Americas as a percentage of total revenues
36
%
 
32
%
 
 
 
 
EMEA as a percentage of total revenues
32
%
 
29
%
 
 
 
 
APAC as a percentage of total revenues
32
%
 
39
%
 
 
 
 
The Americas revenues included $10.0 million in revenue from the acquired PKI Imaging business. The remaining increase was due to higher sales of digital detectors. EMEA revenues included $11.8 million in revenue from the acquired PKI Imaging business. The decrease in non-acquisition EMEA revenues was due to a decrease in revenue from digital detectors partially offset by higher sales of X-ray tubes. APAC revenues included $4.9 million in revenue from the acquired PKI Imaging business. The decrease in non-acquisition APAC revenues was due to lower shipments of CT tubes and digital detectors.
Gross Margin
 
Three Months Ended
 
 
 
 
(In millions)
June 30, 2017
 
July 1, 2016
 
$ Change
 
% Change
Medical
$
45.3

 
$
52.1

 
$
(6.8
)
 
(13.1
)%
Industrial
14.2

 
10.9

 
3.3

 
30.3
 %
Total gross margin
$
59.5

 
$
63.0

 
$
(3.5
)
 
(5.6
)%
Medical gross margin %
33.6
%
 
41.4
%
 
 
 
 
Industrial gross margin %
40.1
%
 
42.7
%
 
 
 
 
Total gross margin %
35.0
%
 
41.6
%
 
 
 
 
The decrease in total gross margin percentage was primarily due to higher amortization of intangible assets, a step-up inventory costs as a result of purchase price accounting related to the acquisition of the PKI Imaging business, and continued price erosion in digital detectors. The decrease in medical gross margin percentage was primarily due to the reasons stated above and strong sales of CT tubes in the prior-year quarter. The decrease in industrial gross margin percentage was primarily due to a change in product mix.
Operating Expenses
 
Three Months Ended
 
 
 
 
(In millions)
June 30, 2017
 
July 1, 2016
 
$ Change
 
% Change
Research and development (1)
$
17.7

 
$
14.0

 
$
3.7

 
26.4
%
As a percentage of total revenues
10.4
%
 
9.2
%
 
 
 
 
Selling, general and administrative (2)
$
26.3

 
$
20.6

 
$
5.7

 
27.7
%
As a percentage of total revenues
15.5
%
 
13.6
%
 
 
 
 
Operating expenses
$
44.0

 
$
34.6

 
$
9.4

 
27.2
%
As a percentage of total revenues
25.9
%
 
22.9
%
 
 
 
 
(1) Research and development expenses included $0.0 million and $0.4 million allocated to us by Varian in the three months ended June 30, 2017 and three months ended July 1, 2016, respectively.

(2) Selling, general and administrative expenses include $0.0 million and $8.6 million of corporate costs allocated to us by Varian in the three months ended June 30, 2017 and the three months ended July 1, 2016, respectively.

 Research and Development

28


The increase in research and development expenses was due to acceleration and development of CT X-ray tubes and digital detectors, and includes approximately $2.7 million related to the acquired PKI Imaging business. 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 9% of annual revenues is the appropriate range that will allow us to continue to innovate and bring new products to market for our global OEM customers.
Selling, General and Administrative
Selling, general and administrative expenses increased due to approximately $2.3 million of acquisition and integration related costs, increased marketing personnel expenses, partially offset by lower corporate and administration expenses as the prior quarter included costs allocated from Varian. Selling, general and administrative expenses includes approximately $2.5 million related to the acquired PKI Imaging business. Excluding the aforementioned $2.3 million of acquisition and integration related costs, selling, general and administrative expenses as percentage of total revenues was approximately 13.5 percent.
Interest and Other Income (Expense), Net
The following table summarizes the Company’s interest and other income (expense), net:
 
Three Months Ended
 
 
(In millions)
June 30, 2017
 
July 1, 2016
 
$ Change
Interest income
$
0.1

 
$
0.1

 
$

Interest expense
(4.2
)
 
(0.4
)
 
(3.8
)
Other
4.4

 
(1.0
)
 
5.4

Interest and other income (expense), net
$
0.3

 
$
(1.3
)
 
$
1.6

The increase in interest and other income (expense), net was due to increases in income from an equity method investment and foreign currency translation gains, offset by higher interest expense as a result of borrowings under our credit agreement. Interest and other income (expense) in the prior year primarily represents allocations of Varian’s interest expense and loss in an equity method investment.
Taxes on Earnings
 
Three Months Ended
 
June 30, 2017
 
July 1, 2016
Effective tax rate
32.3
%
 
34.3
%

     Our effective tax rate decreased primarily due to differences in forecasted earnings by jurisdiction and overall global tax structure for Varex as a stand-alone company compared to the prior year when Varex was part of Varian. The effective tax rate for the three months ended July 1, 2016 also included discrete items for the quarter.
In general, our effective income tax rate differs from the U.S. federal statutory rate due to increases resulting from U.S. state income tax expense and losses in foreign jurisdictions for which no benefit is recorded due to valuation allowance positions, which is partially offset by decreases due to earnings in other foreign jurisdictions that are taxed at lower rates, a U.S. domestic production activities deduction, and research and development credits.


29


Discussion of Results of Operations for the Nine Months Ended June 30, 2017 Compared to the Nine Months Ended July 1, 2016

Revenues
 
Nine Months Ended
 
 
 
 
(In millions)
June 30, 2017
 
July 1, 2016
 
$ Change
 
% Change
Medical
$
392.1

 
$
370.8

 
$
21.3

 
5.7
%
Industrial
90.3

 
77.2

 
13.1

 
17.0
%
Total revenues
$
482.4

 
$
448.0

 
$
34.4

 
7.7
%
Medical as a percentage of total revenues
81
%
 
83
%
 
 
 
 
Industrial as a percentage of total revenues
19
%
 
17
%
 
 
 
 
Medical revenues increased by $21.3 million primarily due to $17.7 million in revenue from the acquired PKI Imaging business and higher sales of digital detectors, partially offset by decreases in X-ray tubes. Industrial revenues increased by $13.1 million due to $9.0 million in revenue from the acquired PKI Imaging business and higher service and linear accelerator revenue on our security products, along with increased revenue from our industrial X-ray tube products. These increases were offset by declines in industrial detector sales.
Revenues by Region
 
Nine Months Ended
 
 
 
 
(In millions)
June 30, 2017
 
July 1, 2016
 
$ Change
 
% Change
Americas
$
159.7

 
$
161.6

 
$
(1.9
)
 
(1.2
)%
EMEA
150.2

 
132.9

 
17.3

 
13.0
 %
APAC
172.5

 
153.5

 
19.0

 
12.4
 %
Total revenues
$
482.4

 
$
448.0

 
$
34.4

 
7.7
 %
Americas as a percentage of total revenues
33
%
 
36
%
 
 
 
 
EMEA as a percentage of total revenues
31
%
 
30
%
 
 
 
 
APAC as a percentage of total revenues
36
%
 
34
%
 
 
 
 
The Americas revenues include $10.0 million in revenue from the acquired PKI Imaging business, which was more than offset by lower sales of X-ray sources, digital detectors and high voltage connectors to our OEM customers. EMEA revenues include $11.8 million in revenue from the acquired PKI Imaging business and also had higher service and linear accelerator revenues from our security products, partially offset by decreased sales of X-ray tubes. APAC revenues also had $4.9 million in revenue from the acquired PKI Imaging business and also had higher sales of our X-ray tubes, digital detectors and high voltage connectors. The increased X-ray tube sales in the APAC region were due to higher volumes of CT tubes, while the increased digital detector sales were due to higher shipments of radiographic detectors to China.

30


Gross Margin
 
Nine Months Ended
 
 
 
 
(In millions)
June 30, 2017
 
July 1, 2016
 
$ Change
 
% Change
Medical
$
136.9

 
$
144.8

 
$
(7.9
)
 
(5.5
)%
Industrial
38.9

 
34.4

 
4.5

 
13.1
 %
Total gross margin
$
175.8

 
$
179.2

 
$
(3.4
)
 
(1.9
)%
Medical gross margin %
34.9
%
 
39.1
%
 
 
 
 
Industrial gross margin %
43.1
%
 
44.6
%
 
 
 
 
Total gross margin %
36.4
%
 
40.0
%
 
 
 
 
Medical gross margin percentage decreased from the prior year primarily due to higher amortization of intangible assets, a step-up in inventory costs as a result of purchase price accounting related to the acquisition of the PKI Imaging business, changes in product mix related to higher sales of lower-margin products, price erosion in lower-tier radiographic digital detectors and higher costs of quality. Industrial gross margin decreased as a percentage of revenues due to a change in product mix from industrial digital detectors to industrial linear accelerators and X-ray tubes.
Operating Expenses
 
Nine Months Ended
 
 
 
 
(In millions)
June 30, 2017
 
July 1, 2016
 
$ Change
 
% Change
Research and development (1)
$
45.4

 
$
39.6

 
$
5.8

 
14.6
%
As a percentage of total revenues
9.4
%
 
8.8
%
 
 
 
 
Selling, general and administrative (2)
$
73.3

 
$
63.5

 
$
9.8

 
15.4
%
As a percentage of total revenues
15.2
%
 
14.2
%
 
 
 
 
Operating expenses
$
118.7

 
$
103.1

 
$
15.6

 
15.1
%
As a percentage of total revenues
24.6
%
 
23.0
%
 
 
 
 
(1) Research and development expenses included $0.0 million and $0.9 million allocated to us by Varian in the nine months ended June 30, 2017 and nine months ended July 1, 2016, respectively.

(2) Selling, general and administrative expenses include $12.4 million and $28.2 million of corporate costs allocated to us by Varian in the nine months ended June 30, 2017 and nine months ended July 1, 2016, respectively.

 Research and Development
Research and development expenses increased due to an acceleration of product development, which increased prototype-related material expenses as compared to the same period a year ago. Included in research and development expenses is approximately $2.7 million related to the acquired PKI Imaging business.
Selling, General and Administrative
Selling, general and administrative expenses increased due to higher acquisition and integration related costs, increased marketing personnel-related expenses, and increased third-party expenses. Selling, general and administrative expenses included approximately $2.5 million related to the acquired PKI Imaging business. During the nine months ended June 30, 2017, we received an allocation from Varian of $12.4 million for corporate activities, which included $3.0 million of direct separation costs. We also incurred additional personnel and consulting costs in connection with the separation during the nine months ended June 30, 2017.
Interest and Other Income (Expense), Net
The following table summarizes the Company’s interest and other income (expense), net:

31


 
Nine Months Ended
 
 
(In millions)
June 30, 2017
 
July 1, 2016
 
$ Change
Interest income
$
0.2

 
$
0.4

 
$
(0.2
)
Interest expense
(5.8
)
 
(1.3
)
 
(4.5
)
Other
5.1

 
(2.0
)
 
7.1

Interest and other income (expense), net
$
(0.5
)
 
$
(2.9
)
 
$
2.4

The increase in interest and other income (expense), net was due to increases in income from an equity method investment and foreign currency translation gains, partially offset by higher interest expense as a result of borrowings under our credit agreement. Interest and other income (expense) in the prior year primarily represents allocations of Varian’s interest expense and loss in an equity method investment.
Taxes on Earnings
 
Nine Months Ended
 
June 30, 2017
 
July 1, 2016
Effective tax rate
34.6
%
 
36.1
%

     Our effective tax rate decreased primarily due to a change in the estimated annual effective rate used for June 30, 2017, which was computed based on forecasted earnings. This change is the result of differences in forecast earnings by jurisdiction and overall global tax structure for Varex as a stand-alone company compared to the prior year when Varex was part of Varian. The effective tax rate for the nine months ended July 1, 2016 also included discrete items for that period.
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 total backlog at June 30, 2017 was $226.2 million, a decrease of 8.9% from the backlog of $248.4 million at September 30, 2016, which was primarily due to several of our customers providing quarterly orders rather than annual orders.
Orders may be revised or canceled, either according to their terms or as customers’ needs change. Consequently, it is difficult to predict with certainty the amount of backlog that will result in revenues. We perform a quarterly review to verify that outstanding orders in the backlog remain valid. Aged orders that are not expected to be converted to revenues are deemed dormant and are reflected as a reduction in the backlog amounts in the period identified.
Liquidity and Capital Resources
Prior to the separation, Varian provided financing, cash management and other treasury services to us. As part of Varian, we were dependent upon Varian for all of our working capital and financing requirements, as Varian uses a centralized approach to cash management and financing of its operations. Cash transferred to and from Varian is reflected in net parent investment in the accompanying historical condensed consolidated financial statements. Accordingly, none of Varian’s cash, cash equivalents or debt at the corporate level has been assigned to us in the condensed consolidated financial statements. Cash and cash equivalents included in the condensed consolidated balance sheets primarily reflect cash and cash equivalents from acquired entities that are specifically attributable to us.
We assess our liquidity in terms of our ability to generate cash to fund our operating and investing activities. We continue to generate substantial cash from operating activities and believe that our operating cash flow, credit facility, and other sources of liquidity 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. Although we believe that our future cash from operations, together with our access to banking and capital markets, will provide adequate resources to fund our operating and financing needs, our access to, and the availability of, financing on acceptable terms in the future will be affected by many factors, including: (i) the liquidity of the overall capital markets and (ii) the current state of the economy. There can be no assurances that we will continue to have access to these markets on terms acceptable to us. See “Risk Factors” for a further discussion. At June 30, 2017. we had $478.7 million in long-term debt and $20.0 million of current maturities of long-term debt, net of deferred issuance costs of $11.3 million.

32


Cash and Cash Equivalents
The following table summarizes our cash and cash equivalents:
(In millions)
June 30, 2017
 
September 30, 2016
Cash and cash equivalents
$
89.3

 
$
36.5

In accordance with the Separation and Distribution Agreement, we transferred $27.1 million during the three months ended June 30, 2017, which represented all cash and cash equivalents in excess of $5 million to Varian, other than any cash and cash equivalents held by MeVis and any Varex entities in order to complete the transfer of certain assets and subsidiaries from Varian. Funds held to complete these asset and subsidiary transfers was approximately $18.6 million as of June 30, 2017.
On May 1, 2017 and in connection with the acquisition of PKI Imaging, we entered into a new secured Revolving Credit Facility in an aggregate principal amount of up to $200 million with a five-year term, and a secured Term Facility in an aggregate principal amount of $400 million. The Term Facility will be repaid over five years, with 5.0% payable in quarterly installments during each of the first two years of the term thereof, 7.5% payable in quarterly installments during the third and fourth years of the term thereof, and 10% payable in quarterly installments in the fifth year of the term thereof, with the remaining amount due at maturity. We used the net proceeds from the Term Facility, and the net proceeds from approximately $97 million drawn on the Revolving Credit Facility, to pay the approximately $276 million purchase price for the acquisition of PKI Imaging, plus related credit facility fees, and to repay all of our obligations under the Previous Credit Agreement. Refer to Note 12 “Borrowings” for more information.
Cash Flows
 
Nine Months Ended
(In millions)
June 30, 2017
 
July 1, 2016
Net cash flow provided by (used in):
 
 
 
Operating activities
$
59.8

 
$
54.4

Investing activities
(283.6
)
 
(16.9
)
Financing activities
275.9

 
(24.1
)
Effects of exchange rate changes on cash and cash equivalents
0.7

 
0.1

Net increase in cash and cash equivalents
$
52.8

 
$
13.5


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

For the nine months ended June 30, 2017, net cash provided by operating activities was $59.8 million and consisted of net earnings of $37.0 million, increases from non-cash items of $28.3 million and decreases from operating assets and liabilities activities of $6.1 million. Operating assets and liabilities activity primarily consisted of increases in inventories of $24.1 million, prepaid expenses and other assets of $7.4 million, increases in accounts payable of $10.7 million and increases in accrued operating liabilities and other long-term liabilities of $9.5 million.
For the nine months ended July 1, 2016, net cash provided by operating activities was $54.4 million and primarily consisted of net earnings of $46.8 million, non-cash items of $20.8 million and decreases from operating assets and liabilities activities of $13.2 million. Operating assets and liabilities activity consisted of increases in inventories of $22.6 million, increases in deferred revenues of 1.9 million and decreases in accounts payable of $1.5 million.
Net Cash Used in Investing Activities. Net cash used in investing activities was $283.6 million and $16.9 million for the nine months ended June 30, 2017 and the nine months ended July 1, 2016, respectively. Net cash used in investing activities for the nine months ended June 30, 2017 related to PKI Imaging for $276.0 million and capital expenditures for property plant and equipment of $7.6 million. Net cash used in investing activities for the nine months ended July 1, 2016 related to capital expenditures for property plant and equipment of $24.2 million offset by sales of available-for-sale securities of $8.6 million.
Net Cash Provided by (Used in) Financing Activities. Financing activities for the nine months ended June 30, 2017 primarily consisted of borrowings under our credit agreements of $744.0 million and net transfers from Varian of $3.3 million, partially offset by

33


distributions to Varian of $227.1 million, repayments of borrowings of $234.0 million and payment of debt issuance costs of $11.9 million. Financing activities for the nine months ended July 1, 2016 consisted of transfers to Varian of $24.4 million.
Days Sales Outstanding
Trade accounts receivable days sales outstanding (“DSO”) was 66 days at June 30, 2017 and September 30, 2016. 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.
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. For the remainder of calendar year 2017, we estimate that we have fixed cost commitments of $8.1 million related to this amended agreement. The fixed cost commitment for future periods will be determined and approved by the dpiX board of directors at the beginning of each calendar year. The amended agreement will continue unless the ownership structure of dpiX changes (as defined in the amended agreement).
In October 2015, 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 June 30, 2017, noncontrolling shareholders together held approximately 0.5 million shares of MeVis, representing 26.3% of the outstanding shares.
Contingencies
From time to time, we are a party to or otherwise involved in legal proceedings, claims and government inspections or investigations and other legal 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. See Note 10 “Commitments and Contingencies” in the notes to the condensed consolidated financial statements, which discussion is incorporated herein by reference.
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. 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 June 30, 2017, 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.
Recent Accounting Standards or Updates Not Yet Effective
See Note 3, “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 consolidated financial statements.
Item 3. Quantitative and Qualitative Disclosures about Market Risks

34


We are exposed to four primary types of market risks: foreign currency exchange rate risk, credit and counterparty risk, interest rate risk and commodity price risk.
Foreign Currency Exchange Rate Risk
A significant portion of our customers are outside the United States and our products are generally priced in U.S. Dollars. A strong U.S. Dollar may result in pricing pressure for our customers that are located outside the United States and that conduct their businesses in currencies other than the U.S. Dollar. Such pricing pressure has caused, and could continue to cause, some of our customers to ask for discounted prices, delay purchasing decisions, consider moving to in-sourcing supply of components or migrating to lower cost alternatives. In addition, because our business is global and some payments may be made in local currency, fluctuations in foreign currency exchange rates can impact our revenues and expenses and/or the profitability in U.S. Dollars of products and services that we provide in foreign markets.
Credit and Counterparty Risk
We use a centralized approach to manage substantially all of our cash and to finance our operations. Our cash and cash equivalents may be exposed to a concentration of credit risk and we may also be exposed to credit risk and interest rate risk to the extent that we enter into credit facilities.
We perform ongoing credit evaluations of our customers and we maintain strong credit controls in evaluating and granting customer credit, including performing ongoing evaluations of our customers’ financial condition and creditworthiness and often using letters of credit and requiring industrial customers to provide a down payment.
Interest Rate Risk
At June 30, 2017, we had gross borrowings of $510 million. Borrowings under our credit facilities bear interest at floating interest rates. As a result, we are exposed to fluctuations in interest rates to the extent of our borrowings under the credit facilities. As part of our overall risk management program, we entered into several interest rate swaps designed as cash flow hedges, to hedge the floating LIBOR components of our interest rate which represented a notional value of $296.3 million of our debt as of June 30, 2017.
Commodity Price Risk
We are exposed to market risks related to volatility in the prices of raw materials used in our products. The prices of these raw materials fluctuate in response to changes in supply and demand fundamentals and our product margins and level of profitability tend to fluctuate with changes in these raw materials prices. We try to protect against such volatility through various business strategies. During the three and nine months ended June 30, 2017, we did not have any commodity derivative instruments in place to manage our exposure to price changes.
Item 4. Controls and Procedures
Based on the evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)) under the Securities Exchange Act of 1934), as amended (the “Exchange Act”) required by Rules 13a-15(b) or 15d-15(b) under the Exchange Act, our Chief Executive Officer and our Chief Financial Officer have concluded that as of the end of the period covered by this report, our disclosure controls and procedures were effective.
Changes in internal control over financial reporting
There were no changes in our internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

35


PART II
OTHER INFORMATION

Item 1. Legal Proceedings
We are subject to various claims, complaints and legal actions in the normal course of business from time to time. We do not believe we have any currently pending litigation for which the outcome could have a material adverse effect on our operations or financial position.
 
Item 1A. Risk Factors
The following risk factors and other information included in this Quarterly Report should be carefully considered. Although the risk factors described below are the ones management deems significant, additional risks and uncertainties not presently known to us or that we presently deem less significant may also adversely affect our business operations. If any of the following risks or additional risks and uncertainties actually occur, our business, operating results, and financial condition could be adversely affected.
Risks Related to the Company
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.
Varex sells its products to a limited number of OEM customers, many of which are also its competitors with in-house X-ray tube manufacturing operations. Although Varex seeks to broaden its customer base, it will continue to depend on sales to a relatively small number of major customers. Because it often takes significant time to replace lost business, it is likely that Varex’s operating results would be materially and adversely affected if one or more of its major OEM customers were to cancel, delay, or reduce orders in the future.
On January 28, 2017, Varian and Varex entered into a Separation and Distribution Agreement (the “Separation and Distribution Agreement”), whereby Varex became an independent publicly-traded company. Although it is expected that Varian will continue as a major customer of Varex, and while Varex has entered into a Supply Agreement with Varian, there can be no assurance that Varian will continue to source from Varex long-term. Varex’s OEM customers may cancel, delay or reduce orders due to a wide variety of factors, many of which are beyond Varex’s control.
Furthermore, Varex generates significant accounts receivables from the sale of its products and the provision of services to its major customers. Although Varex’s major customers are large corporations, if one or more of these customers were to become insolvent or otherwise be unable or fail to pay for Varex products and services, Varex’s operating results and financial condition could be materially and adversely affected.
Varex may not be able to accurately predict the demand for its products by its OEM customers.
Economic uncertainties over the past few years, natural disasters, and other matters beyond Varex’s control have made it difficult for its OEM customers to accurately forecast and plan future business activities. Such economic uncertainties and natural disasters, as well as other factors, have previously impacted Varex’s business, resulting in inventory reduction and slowdowns in sales at some of these customers. Similar inventory adjustments and slowdowns in sales could occur in the future. Varex’s OEM customers also face inherent competitive issues and new product introduction delays which can result in changes in forecasts. As such, the market and regulatory risks faced by Varex’s OEM customers in the X-ray-based diagnostic imaging space also ultimately impact Varex’s ability to forecast future business. Varex’s agreements for imaging components, such as the recent three-year pricing agreement with Toshiba Medical Systems, may contain purchasing estimates that are based on its customers’ historical purchasing patterns rather than firm commitments, and actual purchasing volumes under the agreements may vary significantly from these estimates. The variation from forecasted purchasing volume may be due, in part, to the increasing life of X-ray tubes, which can result in reduced demand for replacement X-ray tubes in ways Varex may not be able to accurately forecast. Reductions in purchasing patterns have in the past and may in the future materially and adversely affect Varex’s operating results.
Varex competes in highly competitive markets, and it may lose business to its customers or other companies with greater resources or the ability to develop more effective technologies, or it could be forced to reduce its prices.
Rapidly-evolving technology, intense competition and pricing pressure characterize the market in which Varex competes. Varex often competes with companies that have greater financial, marketing and other resources than Varex, including Varex’s customers. If these customers manufacture a greater percentage of their components in house or otherwise lower external sourcing

36


costs, which may occur for a number of reasons, including a strong U.S. Dollar, Varex could experience reductions in purchas