On February 11th, Varex Imaging Corporation published financial results for its first fiscal quarter in FY2020 or calendar Q4 2019. These results show that overall sales revenue grew during the quarter driven by higher revenues from both the medical and industrial imaging segments. Overall sales revenue for calendar Q4 2019 was $200.1 million, compared with $185.7 million in Q4 2019 2018, an increase of +7.8% year-on-year. The strong quarterly result took cumulative sales revenue for the calendar year (CY) 2019 to $795 million, compared with $783 million in 2018, an increase of approximately +1.5% year-on-year.
The company has two reportable operating segments, medical and industrial imaging, which accounted for approximately 77% and 23% of sales revenues respectively. The sales growth during 2019 was predominately driven by the industrial imaging segment although the medical imaging segment also contributed toward growth. In terms of additional revenue contribution, industrial imaging contributed approximately $10 million and medical imaging contributed approximately $2 million.
Medical Imaging Segment
The medical imaging segment returned to revenue growth during calendar Q4 2019 following three consecutive quarters of revenue contraction, although 2018 was a tough comparable due to higher growth. The Q4 2019 sales revenue was $156 million, compared with $144 million in Q4 2018, an increase of approximately +8% year-on-year. On a calendar-year basis, this propelled cumulative sales revenue to $608.5 million in 2019, compared with $606.7 million in 2018, a marginal increase of +0.3% year-on-year.
The weaker sales results during 2019 were predominantly driven by lower sales of radiographic digital detectors due to US-China trade-tariff related actions. During the fiscal year 2019, the company experienced a reduction in radiographic detector product sales of approximately $20 million in China as a direct result of tariff-related actions. This was led by the non-OEM aftermarket segment. It is estimated that trade-tariff related actions had an adverse impact on the sales revenue of approximately 2-3% during the companies fiscal year 2019, despite taking compensating actions such as shifting production as well as applying for temporary exclusion from section 301 on components being imported into the U.S. from China. Although the US-China trade tensions remain, the situation appears to be more stable and during the Q1 FY2020 earnings call, Sunny Sanyal CEO commented: “we did not see any change in our customer ordering patterns or any other behaviour change due to the tariffs (during the quarter)”. Furthermore, Varex has begun the production of radiographic detectors in China as well as making its first shipments to local Chinese OEM customers, so the company is already on a path toward reestablishing some of this lost business. In contrast with radiographic FPDs, the company continued to do steady business for high-end dynamic detectors with both Chinese and global OEMs. In addition, during CY Q4 2019, the company added incremental business with some Chinese dental equipment OEMs, including entering into one long-term agreement to supply detectors for high-end applications.
The strength in sales activity during 2019 was predominately driven by strong product demand for oncology, computed tomography (CT) and dental applications, which fully offset declines from the radiographic detector business. The demand from Chinese OEMs for CT tubes was strong, particularly for 16 slice value and mid-range CT systems on a volume basis. This demand is off the back of various purchase agreements with local Chinese OEMs as well as continued investment into its Wuxi facility to service business in China. The companies “local for local” strategy has been about increasing local X-ray tube and digital detector manufacture as well as service and support with the aim of being global partners for local business.
Pricing agreement with Canon Medical Systems
Canon Medical Systems is the companies largest single customer and alongside publishing its financial results, Varex announced that it has recently renewed a three-year pricing agreement effective for calendar years 2020 to 2022. The agreement encompasses CT tubes and heat exchangers for integration into Canon CT imaging systems and is estimated to generate approximately $385 million in product sales revenue over the term of the agreement. This revenue figure is based on an estimate of the expected CT tube volumes. Varex also supplies Canon Medical Systems with digital detectors and high voltage connectors through separate agreements. Over 50% of the Varex medical imaging business is delivered under long-term agreements and this agreement is one of approximately 8 for the supply of CT tubes.
Industrial Imaging Segment
The industrial imaging segment grew during calendar Q4 2019 which is the continuation of consecutive quarterly growth. The Q4 2019 sales revenue was $44.5 million, compared with $41.8 million in Q4 2018, an increase of approximately +7% year-on-year. On a calendar-year basis, this propelled cumulative sales revenue to reach $186.5 million in 2019, compared with $176.2 million in 2018, an increase of +5.8% year-on-year. The growth from the industrial segment during 2019 was driven by the continued adoption of next-generation technology and digitisation of inspection processes across a variety of vertical markets. Growth from the industrial segment was led by higher sales of products for airport baggage screening as well as non-destructive testing applications within oil & gas, food and manufacturing verticals.
The general sentiment on the Q1 FY2020 earnings call was that it is “too early to tell” whether the Coronavirus is having a negative or positive impact on the Varex business. The business is experiencing some additional detector demand from sites directly impacted by the Coronavirus which has been “helpful”. That being said, these additional product sales appear to be more incremental rather than a step-change in demand, therefore may not have a material impact on the sales results for the next quarter. From a cost perspective, the business is not experiencing a real cost impact. The company is currently trading on inventory as well as operating off its existing supply-chain, therefore the cost impact has been minimal so far. Sunny commented that if the virus persists, then it has the potential to have a larger impact on the medical imaging industry, which includes Varex Imaging. For now, analysts appear to be recognising additional uncertainty or volatility in forward-looking revenue and profit figures on a quarter-by-quarter basis.
Sales revenue expectations for the coming 12-months
Despite the additional uncertainty the Coronavirus presents, Varex maintained its forward-looking guidance on revenues and earnings per share with no changes from its previous guidance. For the fiscal year 2020, the company expects revenues to be in a range of $790 to $805 million, indicating overall annualised sales growth within the one to three per cent range. Varex doesn’t provide forward guidance on financials by segment, although during the Q4 FY2019 earnings call, Clarence Verhoef CFO, noted that the “recovery” of the China radiographic detector business is not currently incorporated into this forward revenue estimate. Based on the current distribution of revenues between medical and industrial, if the industrial segment were to continue to grow at a faster pace within the 5-7% range then this would imply growth from medical within the 1-2% range.
Closure of acquired Perkin Elmer Santa Clara operations
During May 2017, the company completed the acquisition of the medical imaging business of PerkinElmer Inc which consisted of PerkinElmer Medical Holdings Inc and Dexela Limited as well as other assets within subsidiary companies relating to digital flat panel X-ray detectors that serve as components for industrial, medical, dental and veterinary X-ray imaging systems. The acquisition included approximately 280 employees, with operations in Santa Clara, California as well as operations in Germany, the Netherlands and the United Kingdom. Following a period of unfavourable performance from the Santa Clara operations, during July 2019, the company announced that it would be closing this facility. This announcement coincided with the company extending its “local for local” strategy into Europe, by expanding the production capacity of digital x-ray detectors in Germany while shifting the manufacture of heat exchangers to the Philippines. These global footprint changes are expected to help manage and mitigate any negative impact from the ongoing trade war between US-China.
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