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.
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 27, 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 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 forecast. 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 may contain purchasing estimates that are based on its customers’ historical purchasing patterns, 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 costs, which may occur for a number of reasons, including a strong U.S. Dollar, Varex could experience reductions in purchasing volume by, or loss of, one or more of these customers. Such a reduction or loss may have a material and adverse effect on its business. Some of the major diagnostic imaging systems companies, which are the primary OEM customers for Varex’s X-ray components, also
manufacture X-ray components, including X-ray tubes, for use in their own imaging systems products. Varex must compete with these in-house manufacturing operations for business. In addition, Varex competes against other stand-alone, independent X-ray tube manufacturers for both the OEM business of major diagnostic imaging equipment manufacturers and the independent servicing business for X-ray tubes. The market for flat panel detectors is also very competitive, and Varex faces intense competition from over a dozen smaller competitors. As a result of these competitive dynamics, in order for Varex to effectively retain the business of its customers and compete with its competitors, it must have an advantage in one or more significant areas, such as lower product cost, better product quality and/or superior technology and/or performance.
With Varex’s industrial products, Varex competes with other OEM suppliers, primarily outside of the United States. The market for its X-ray tube and flat panel products used for nondestructive testing in industrial applications is small and highly fragmented. In addition, some of Varex’s competitors outside the United States may have resources and support from their governments that Varex cannot replicate, such as preferences for local manufacturers, and may not be subject to the same trade compliance regulations to which Varex is subject. Therefore, Varex’s ability to compete in certain high-growth markets may be limited as compared to its competitors.
Existing competitors’ actions and new entrants may materially and adversely affect Varex’s ability to compete. These competitors could develop technologies and products that are more effective than those Varex currently uses or produces or that could render its products obsolete or noncompetitive. In addition, the timing of Varex’s competitors’ introduction of products into the market could affect the market acceptance and sales of Varex’s products. Some competitors offer specialized products that provide, or may be perceived by customers to provide, a marketing advantage over Varex’s products. Also, some of Varex’s competitors may not be subject to the same standards, regulatory and/or other legal requirements to which Varex is subject, and therefore, they could have a competitive advantage in developing, manufacturing and marketing products and services. Any inability to develop, gain regulatory approval for and supply commercial quantities of competitive products to the market as quickly and effectively as Varex’s competitors could limit market acceptance of Varex’s products and reduce its sales. In addition, some of its smaller competitors could be acquired by larger companies that have greater financial strength, which could enable them to compete more aggressively. Varex’s competitors could also acquire some of its customers, suppliers or distributors, which could disrupt supply or distribution arrangements and result in loss of customers and less predictable and reduced revenues in Varex’s businesses. Any of these competitive factors could negatively and materially affect Varex’s pricing, sales, revenues, market share and gross margins and its ability to maintain or increase its operating margins.
Varex’s success depends on the successful development, introduction and commercialization of new generations of products and enhancements to or simplifications of existing product lines.
Rapid change and technological innovation characterize the markets in which Varex operates, particularly with respect to flat panel technology. Varex’s customers use its products in their medical diagnostic, security and industrial imaging systems, and Varex must continually introduce new products at competitive costs while also improving existing products with higher quality, lower costs and increased features. In order to be successful, Varex must anticipate its customers’ needs and demands as well as potential shifts in market preferences.
Varex’s failure to do so has in the past resulted and may in the future result in the loss of customers and an adverse impact to its financial performance. With a relatively strong U.S. Dollar, Varex’s ability to meet its customers’ pricing expectations is particularly challenging and may result in erosion of product margin and market share.
Varex may need to spend more time and money than it expects to develop and introduce new products or enhancements and, even if Varex succeeds, Varex may not be able to recover all or a meaningful part of its investment. Once introduced, new products may materially and adversely impact sales of Varex’s existing products, or make them less desirable or even obsolete, which could materially and adversely impact Varex’s revenues and operating results. In addition, certain costs, including installation and warranty costs, associated with new products may be proportionately greater than the costs associated with other products, and may therefore disproportionately, materially, and adversely affect Varex’s gross and operating margins. If Varex is unable to lower these costs over time, Varex’s operating results could be materially and adversely affected. Some of the electronic components and integrated circuits used in Varex’s flat panel detectors are susceptible to discontinuance and obsolescence risks, which may force Varex to incorporate newer generations of these components resulting in unplanned additional R&D expenses, delays in launch of new products, supply disruption, or inventory write downs.
Varex’s ability to successfully develop and introduce new products and product enhancements and simplifications, and the revenues and costs associated with these efforts, are affected by Varex’s ability to:
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properly identify customer needs or long-term customer demands;
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prove the feasibility of new products;
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limit the time required from proof of feasibility to routine production;
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timely and efficiently comply with internal quality assurance systems and processes;
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limit the timing and cost of regulatory approvals;
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accurately predict and control costs associated with inventory overruns caused by phase-in of new products and phase-out of old products;
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price its products competitively and profitably, which can be particularly difficult with a strong U.S. Dollar;
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manufacture, deliver and install its products in sufficient volumes on time and accurately predict and control costs associated with manufacturing installation, warranty and maintenance of the products;
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appropriately manage its supply chain;
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manage customer acceptance and payment for products; and
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anticipate, respond to and compete successfully with competitors.
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Furthermore, as discussed in greater detail elsewhere in this “Risk Factors” section, Varex cannot be sure that it will be able to successfully develop, manufacture or introduce new products or enhancements, the roll-out of which involves compliance with complex quality assurance processes, including the Quality System Regulation (“QSR”) of the U.S. Food and Drug Administration (“FDA”). Failure to complete these processes timely and efficiently could result in delays that could affect Varex’s ability to attract and retain customers, or could cause customers to delay or cancel orders, causing Varex’s revenues and operating results to be materially and adversely affected.
A disruption at Varex’s manufacturing facilities in Salt Lake City, Utah; Calamba City, Philippines or Las Vegas, Nevada could materially and adversely affect its business.
The majority of Varex’s products are manufactured in its manufacturing facility in Salt Lake City, Utah. Varex’s manufacturing operations are subject to potential power failures, the breakdown, failure or substandard performance of equipment, the improper installation or operation of equipment, and natural or other disasters. Loss or damage to this manufacturing facility due to any of these factors or otherwise could materially and adversely affect Varex’s ability to manufacture sufficient quantities of its products or otherwise deliver products to meet customer demand or contractual requirements which may result in a loss of revenue and other adverse business consequences. Because of the time required to obtain regulatory approval and licensing of a manufacturing facility, Varex may not be available on a timely basis to replace any lost manufacturing capacity. The occurrence of these or any other operational issues at Varex’s manufacturing facilities could have a material and adverse effect on Varex’s business, financial condition and results of operations. In addition, some of Varex’s products from the Claymount acquisition are also manufactured in its Calamba City, Philippines manufacturing facility, which is subject to similar risks but may also face additional regulatory and political risks which could impact Varex’s ability to manufacture and ship products in a timely manner or at all. Varex manufactures its security products in Las Vegas, Nevada, and these operations are also subject to potential power failures, the breakdown, failure or substandard performance of equipment, the improper installation or operation of equipment, and natural or other disasters which could materially and adversely affect Varex’s ability to deliver products to meet customer demand.
Significantly more than half of Varex’s revenues are generated from customers located outside the United States, and economic, political and other risks associated with international sales and operations could materially and adversely affect Varex’s sales or make them less predictable.
Varex conducts business globally. As a result, Varex must provide significant service and support globally, which in the past was in part provided by Varian. Varex intends to continue to expand its presence in international markets and expects to expend significant resources in doing so. Varex cannot be sure that it will be able to meet its sales, service and support objectives or obligations in these international markets, or recover its investments. Varex’s future results could be harmed by a variety of factors, including:
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currency fluctuations, and in particular the strength of the U.S. Dollar relative to many currencies, which have and may in the future adversely affect Varex’s financial results and cause some customers to delay purchasing decisions or move to in-sourcing supply or migrate to lower cost alternatives or ask for additional discounts;
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the longer payment cycles associated with many customers located outside the United States;
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difficulties in interpreting or enforcing agreements and collecting receivables through many foreign countries’ legal systems;
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changes in restrictions on trade between the United States and other countries or unstable regional political and economic conditions, such as those that may result from the outcome of the 2016 U.S. presidential election;
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changes in the political, regulatory, safety or economic conditions in a country or region, including as a result of the United Kingdom’s June 2016 vote to leave the European Union (“Brexit”) or the change in the U.S. administration;
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the imposition by governments of additional taxes, tariffs, global economic sanctions programs or other restrictions on foreign trade;
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any inability to obtain required export or import licenses or approvals;
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failure to comply with export laws and requirements, which may result in civil or criminal penalties and restrictions on Varex’s ability to export its products, particularly its industrial linear accelerator products;
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risks unique to the Chinese market, including import barriers and preferences for local manufacturers;
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failure to obtain proper business licenses or other documentation or to otherwise comply with local laws and requirements regarding marketing, sales, service or any other business Varex conducts in a foreign jurisdiction, which may result in civil or criminal penalties and restrictions on its ability to conduct business in that jurisdiction; and,
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the possibility that it may be more difficult to protect Varex’s intellectual property in foreign countries.
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Although Varex’s sales fluctuate from period to period, in recent years Varex’s international region has represented a larger share of its business. The more Varex depends on sales in the international region, the more vulnerable Varex becomes to these factors.
Varex’s effective tax rate is impacted by tax laws in both the United States and in the countries in which its international subsidiaries do business. Earnings from Varex’s international region are generally taxed at rates lower than U.S. rates. A change in the percentage of Varex’s total earnings from the international region, a change in the mix of particular tax jurisdictions within the international region, or a change in currency exchange rates, could cause Varex’s effective tax rate to increase or decrease. Also, Varex is not currently taxed in the United States on certain undistributed earnings of certain foreign subsidiaries. These earnings could become subject to incremental foreign withholding or U.S. federal and state taxes should they either be deemed to be or actually are remitted to the United States, in which case Varex’s financial results could be materially and adversely affected. In addition, changes in the valuation of Varex’s deferred tax assets or liabilities, changes in tax laws or rates, changes in the interpretation of tax laws or other changes beyond Varex’s control could materially and adversely affect its financial position and results of operations.
Varex’s results have been and may continue to be affected by continuing worldwide economic instability, including changes in foreign currency exchange rates and fluctuations in the price of crude oil and other commodities.
The global economy has been impacted by a number of economic and political factors. In many markets, these conditions have shrunk capital equipment budgets, slowed decision-making and made it difficult for Varex’s customers and vendors to accurately forecast and plan future business activities. This, in turn, has caused Varex’s customers to be more cautious with, and sometimes freeze, delay or dramatically reduce purchases and capital project expenditures. Some countries have adopted and may in the future adopt austerity or stimulus programs that could positively or negatively affect Varex’s results from period to period, making it difficult for investors to compare its financial results. In addition, the outcome of the 2016 U.S. presidential election and the announcement of Brexit and the withdrawal of the United Kingdom from the European Union may also create global economic uncertainty, which may cause our customers to reduce their spending, which in turn, could adversely affect our business, financial condition, operating results and cash flows. An uncertain economic environment may also disrupt supply or affect our service business, as customers’ constrained budgets may result in pricing pressure, extended warranty provisions and even cancellation of service contracts.
In addition, concerns over continued economic instability could make it more difficult for Varex to collect outstanding receivables. A continued weak or deteriorating healthcare market would inevitably materially and adversely affect Varex’s business, financial conditions and results of operations.
Because Varex’s products are generally priced in U.S. Dollars, strengthening of the U.S. Dollar has caused, and could continue to cause, some customers to ask for additional discounts, delay purchasing decisions, or consider moving to in-sourcing supply of such components or migrating to lower cost alternatives. Further, because Varex’s business is global and some payments may be made in local currency, fluctuations in foreign currency exchange rates can impact its results by affecting product demand, or its revenues and expenses and/or the profitability in U.S. Dollars of products and services that Varex provides in foreign markets.
Changes in monetary or other policies here and abroad, including as a result of economic and/or political instability or in reaction thereto, would also likely affect foreign currency exchange rates. Furthermore, in the event that one or more European countries were to replace the Euro with another currency, Varex’s sales in these countries or in Europe generally, would likely be materially and adversely affected until such time as stable exchange rates are established.
Additionally, fluctuations in commodities prices could materially and adversely affect Varex’s performance. Rising commodities prices will increase Varex’s costs and those of Varex’s medical OEM customers, which could in turn result in reduced demand for Varex’s products. Further, Varex’s security product revenues from oil-producing countries, in which Varex has a significant customer base, have in the past suffered as a result of volatility in oil prices and remain sensitive to fluctuations in the future.
The loss of a supplier or any inability to obtain supplies of important components could restrict Varex’s ability to manufacture products, cause delays in its ability to deliver products, or significantly increase its costs.
Varex obtains from a limited group of suppliers or from sole-source suppliers some of the components included in its products, such as wave guides for industrial linear accelerators, transistor arrays, cesium iodide coatings and specialized integrated circuits for flat panel detectors, X-ray tube targets, housings, glass frames, high-voltage cable, bearings and various other components. For example, Varex’s major supplier of its amorphous silicon based thin film transistor arrays (flat panels) used in its digital image detectors is dpiX LLC. Although Varex holds a 40% ownership interest in dpiX, Varex does not have majority voting rights and does not have the power to direct the activities of dpiX. In addition, Varian is Varex’s sole source supplier for a key component in linear accelerators used in Varex’s security and inspection products subsystems, which are specially made for Varex. While Varex entered into a Supply Agreement for this component, there can be no assurance that this component will continue to be available on reasonable terms, or at all.
If Varex loses any of these limited- or sole-source suppliers, if their operations are substantially interrupted, or if any of them fail to meet performance or quality specifications, Varex may be required to obtain and qualify one or more replacement suppliers. Such an event (i) may then also require Varex to redesign or modify its products to incorporate new parts and/or further require Varex to obtain clearance, qualification or certification of these products, including by the FDA, or obtain other applicable regulatory approvals in other countries, or (ii) could significantly increase costs for the affected product and cause material delays in delivery of that and other related products. In addition, manufacturing capacity limitations of any of Varex’s limited or sole-source suppliers or other inability of these suppliers to meet increasing demand could limit growth opportunities for the affected product lines and damage customer relationships. Shortage of, and greater demand for, components and subassemblies could also increase manufacturing costs if the supply/demand imbalance increases the price of the components and subassemblies. Any of these events could materially and adversely affect Varex’s business and financial results.
A shortage or change in source of, or increase in price of, raw materials could restrict Varex’s ability to manufacture products, cause delays, or significantly increase its cost of goods.
Varex relies upon the supplies of certain raw materials such as tungsten, lead, iridium and copper for security and inspection products and copper, lead, tungsten, rhenium, molybdenum zirconium, and various high grades of steel alloy for X-ray tubes. Worldwide demand, availability and pricing of these raw materials have been volatile, and Varex expects that availability and pricing will continue to fluctuate in the future. If supplies are restricted or become unavailable or if prices increase, this could constrain Varex’s manufacturing of affected products, reduce its profit margins or otherwise materially and adversely affect its business.
Pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC has promulgated rules regarding disclosure of the presence in a company’s products of certain metals, known as “conflict minerals,” which are metals mined from the Democratic Republic of the Congo and adjoining countries, as well as procedures regarding a manufacturer’s efforts to identify the sourcing of those minerals from this region. Varex’s complex supply chain may inhibit Varex’s ability to sufficiently verify the origins of the relevant minerals used in its products through the due diligence procedures that it implements, which may harm Varex’s reputation. In addition, Varex may encounter challenges in satisfying customers who require that all of the components of Varex products are certified as conflict-free, which could place Varex at a competitive disadvantage if it is unable to do so. Moreover, complying with these rules requires investigative efforts, which has and will continue to cause Varex to incur associated costs, and could materially and adversely affect the sourcing, supply, and pricing of materials used in Varex’s products, or result in process or manufacturing modifications, all of which could materially and adversely affect its results of operations.
Compliance with U.S. laws and regulations applicable to the marketing, manufacture and distribution of Varex’s products may be costly, and failure or delays in obtaining regulatory clearances or approvals, or failure to comply with applicable laws and regulations could prevent Varex from distributing its products, require Varex to recall its products or result in significant penalties or other harm to Varex’s business.
Some of Varex’s products and those of OEMs that incorporate Varex’s products are subject to extensive and rigorous government regulation in the United States. Compliance with these laws and regulations is expensive and time-consuming, and failure to comply with these laws and regulations could materially and adversely affect Varex’s business.
Most of Varex’s products are Class I devices, with a small number of software products designated as Class II devices. Generally, Varex’s manufacturing operations for medical devices, and those of its third-party manufacturers, are required to comply with the FDA’s QSR, as well as other federal and state regulations for medical devices and radiation-emitting products. The FDA makes announced and unannounced periodic and on-going inspections of medical device manufacturers to determine compliance with QSR and, in connection with these inspections, issues reports, known as Form FDA 483 reports when the FDA believes the manufacturer has failed to comply with applicable regulations and/or procedures. If observations from the FDA issued on Form FDA 483 reports are not addressed and/or corrective action taken in a timely manner and to the FDA’s satisfaction, the FDA may issue a
Warning Letter and/or proceed directly to other forms of enforcement action. Similarly, if a Warning Letter were issued, prompt corrective action to come into compliance would be required. Failure to respond timely to Form FDA 483 observations, a Warning Letter or other notice of noncompliance and to promptly come into compliance could result in the FDA bringing an enforcement action, which could include the total shutdown of Varex’s production facilities, denial of importation rights to the U.S. for products manufactured in overseas locations, adverse publicity and criminal and civil fines. The expense and costs of any corrective actions that Varex may take, which may include products recalls, correction and removal of products from customer sites and/or changes to its product manufacturing and quality systems, could materially and adversely impact Varex’s financial results and may also divert management resources, attention and time. Additionally, if a Warning Letter were issued, customers could delay purchasing decisions or cancel orders, and Varex could face increased pressure from its competitors who could use the Warning Letter against Varex in competitive sales situations, either of which could materially and adversely affect its reputation, business and stock price.
In addition, Varex is required to timely file various reports with the FDA, including reports required by the medical device reporting regulations (“MDRs”), that require that Varex report to regulatory authorities if its devices may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if the malfunction were to recur. In addition, if Varex initiates a correction or removal of a device to reduce a risk to health posed by the device, Varex would be required to submit a publicly-available Correction and Removal report to the FDA and, in many cases, similar reports to other regulatory agencies. This report could be classified by the FDA as a device recall, which could lead to increased scrutiny by the FDA, other international regulatory agencies and Varex’s customers regarding the quality and safety of Varex’s devices. If these MDRs or correction and removal reports are not filed on a timely basis, regulators may impose sanctions and sales of Varex’s products may suffer, and Varex may be subject to product liability or regulatory enforcement actions, all of which could harm its business.
Government regulation may also cause significant delay or even prevent the marketing and full commercialization of future products or services that Varex may develop and/or may impose costly requirements on Varex’s business. Further, as Varex enters new businesses or pursues new business opportunities, Varex will become subject to additional laws, rules and regulations, including FDA and foreign rules and regulations. Becoming familiar with and implementing the infrastructure necessary to comply with these laws, rules and regulations is costly and time consuming. In addition, failure to comply with these laws, rules and regulations could delay the introduction of new products and could materially and adversely affect Varex’s business.
If Varex or any of its suppliers, distributors, agents or customers fail to comply with FDA, Federal Trade Commission and other applicable U.S. regulatory requirements or are perceived to potentially have failed to comply, Varex may face:
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adverse publicity affecting both Varex and its customers;
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increased pressures from competitors;
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investigations by governmental authorities;
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fines, injunctions, civil penalties and criminal prosecutions;
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partial suspensions or total shutdown of production facilities or the imposition of operating restrictions;
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increased difficulty in obtaining required clearances or approvals or losses of clearances or approvals already granted;
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seizures or recalls of Varex products or those of its customers;
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delays in purchasing decisions by customers or cancellation of existing orders;
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the inability to sell Varex products; and,
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difficulty in obtaining product liability or operating insurance at a reasonable cost, or at all.
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Varex is also subject to federal and state laws and regulations of general applicability relating to matters such as environmental protection, safe working conditions, manufacturing practices and other matters. Insurance coverage is not commercially available for violations of law, including the fines, penalties or investigatory costs that Varex may incur as the consequence of regulatory violations; consequently, Varex does not have insurance that would cover this type of liability.
Varex sells certain X-ray tube products as replacements which are subject to medical device certification and product registration laws and regulations, which vary by country, and are subject to change, and Varex may be unable to receive registration approval or renewal of existing registrations if Varex fails to meet regulatory approval requirements or if the process of gaining approval becomes commercially infeasible or impractical.
Varex markets and distributes certain X-ray tubes through distributors and third-party/multi-vendor service organizations which are used as equivalent replacements for specific OEM tubes. Varex is subject to medical device certification and product registration laws, which vary by country and are subject to periodic reviews and changes by regulatory authorities in those countries. For example, to sell X-ray tubes for replacement applications in China, product registrations have to be approved by the Chinese FDA
or province-specific authorities. Registration requirements are subject to change and Varex may not be able to receive registration approval or renewal of existing registrations if Varex fails to meet regulatory approval requirements or if the process of gaining approval becomes commercially infeasible or impractical. Certain of these local laws and regulations have the effect of serving as a barrier to trade and can be difficult to navigate predictably.
In addition, certain countries in which Varex products are sold require products to undergo re-registration if the product is altered in any significant way, and it may be determined that the separation of Varex from Varian, including Varex’s new name, will require these products to be re-registered as Varex products, even if they are physically unchanged.
These registration processes can be costly and time consuming, and customers may determine to purchase products from Varex’s competitors that do not have to be involved in a re-registration process. In addition, Varex’s inability to receive or renew product registrations may prevent Varex from marketing and distributing those particular products for replacement applications in the specific country.
Compliance with foreign laws and regulations applicable to the marketing, manufacture and distribution of Varex’s products may be costly, and failure to comply may result in significant penalties and other harm to Varex’s business.
Regulatory requirements affecting Varex’s operations and sales outside the United States vary from country to country, often differing significantly from those in the United States. In general, outside the United States, some of Varex’s products are regulated as medical devices by foreign governmental agencies similar to the FDA.
For Varex to market its products internationally, Varex must obtain clearances or approvals for products and product modifications. These processes (including, for example, in the European Union (“EU”), the European Economic Area (“EEA”), Switzerland, China, Japan and Canada) can be time consuming, expensive and uncertain, which can delay Varex’s ability to market products in those countries. Delays in the receipt of or failure to receive regulatory approvals, the inclusion of significant limitations on the indicated uses of a product, the loss of previously obtained approvals or failure to comply with existing or future regulatory requirements could restrict or prevent Varex from doing business in a country or subject Varex to a variety of enforcement actions and civil or criminal penalties, which would materially and materially and adversely affect its business. In addition, compliance with changing regulatory schemes, such as what may occur in connection with Brexit, may add additional complexity, cost and delays in marketing or selling Varex’s products. Brexit could lead to legal uncertainty and potentially divergent national laws and regulations and, given the lack of comparable precedent, it is unclear what financial, regulatory and legal implications the withdrawal of the United Kingdom from the EU would have and how such withdrawal would affect Varex.
Within the EU/EEA, Varex must obtain, and in turn affix, a CE mark certification, which is a European marking of conformity that indicates that a product meets the essential requirements of the Medical Device Directive. Compliance with the Medical Device Directive is done through a self-certification process that is then verified by an independent certification body, called a “Notified Body,” which is an organization empowered by the legislature to conduct this verification. Once the CE mark is affixed, the Notified Body will regularly audit Varex to ensure that it remains in compliance with the applicable European laws and Medical Device Directive. By affixing the CE mark to its product, Varex is certifying that its products comply with the laws and regulations required by the EU/EEA countries, thereby allowing the free movement of its products within these countries and others that accept CE mark standards. If Varex cannot support its performance claims and demonstrate compliance with the applicable European laws and Medical Device Directive, Varex would lose its right to affix the CE mark to its products, which would prevent Varex from selling its products within the EU/EEA/Switzerland territory and in other countries that recognize the CE mark. In September 2012, the European Commission adopted a Proposal for a Regulation of the European Parliament and of the Council on Medical Devices and a Proposal for a Regulation of the European Parliament and of the Council on In Vitro Diagnostic Medical Devices, which will, once adopted by the European Parliament and by the Council, replace the existing three Medical Devices Directives. Agreement was reached by member states in May 2016 and drafts of these regulations were published in June 2016. Official publication by the member states is expected by late 2016/early 2017, and the regulations would enter into force in 2020. The new regulations impose stricter requirements for placing medical devices in the market, as well as for Notified Bodies. Varex may be subject to risks associated with additional testing, modification, certification or amendment of its existing market authorizations, or Varex may be required to modify products already installed at its customers’ facilities to comply with the official interpretations of these revised regulations.
Varex is also subject to international laws and regulations of general applicability relating to matters such as environmental protection, safe working conditions, manufacturing practices, as well as others. These are often comparable to, if not more stringent than, the equivalent regulations in the United States. Sales overseas are also affected by regulation of matters such as product standards, packaging, labeling, environmental and product recycling requirements, import and export restrictions, tariffs, duties and taxes.
In addition, Varex is required to timely file various reports with international regulatory authorities similar to the reports it is required to timely file with U.S. regulatory authorities, including reports required by international adverse event reporting regulations. If these reports are not timely filed, regulators may impose sanctions, including temporarily suspending Varex’s market authorizations or CE mark, and sales of its products may suffer.
Further, as Varex enters new businesses or pursue new business opportunities internationally, or as regulatory schemes change, Varex may become subject to additional laws, rules and regulations. Becoming familiar with and implementing the infrastructure necessary to comply with these laws, rules and regulations is costly. Additionally, in some countries, Varex relies or may rely in the future on foreign distributors and agents to assist in complying with foreign regulatory requirements, and Varex cannot be sure that they will always do so. The failure of Varex or its agents to comply with these laws, rules and regulations could delay the introduction of new products, cause reputational harm, result in investigations, fines, injunctions, civil penalties or criminal prosecutions, result in an inability to sell Varex’s products in or to import its products into certain countries, and could materially and adversely affect Varex’s business.
Existing and future healthcare reforms, including the Affordable Care Act and changes to reimbursement rates, may indirectly have a material adverse effect on Varex’s business and results of operations.
Sales of Varex’s products to OEMs in the medical sector indirectly depend on whether adequate reimbursement is available for its customers’ products from a variety of sources, such as government healthcare insurance programs, including U.S. Medicare and Medicaid programs and foreign government programs, private insurance plans, health maintenance organizations and preferred provider organizations. Without adequate reimbursement, the demand for Varex’s customers’ products, and therefore indirectly Varex’s products, may be limited.
Healthcare reform proposals and medical cost containment measures in the U.S. and in many foreign countries could limit the use of Varex’s and its customers’ products, reduce reimbursement available for such use, further tax the sale or use of Varex’s products and further increase the administrative and financial burden of compliance. These reforms and measures, including the uncertainty in the medical community regarding their nature and effect, could have a material and adverse effect on Varex’s and Varex’s customers’ purchasing decisions regarding its products and treatments and could harm Varex’s business, results of operations, financial condition and prospects. Varex cannot predict the specific healthcare programs and regulations that will be ultimately implemented by local, regional and national governments globally. However, any changes that lower reimbursements for Varex’s or its customers’ products and/or procedures using these products, including, for example, existing reimbursement incentives to convert from analog to digital X-ray systems, or changes that reduce medical procedure volumes or increase cost containment pressures on Varex or others in the healthcare sector could materially and adversely affect Varex’s business and results of operations.
On March 23, 2010, President Obama signed into law the Affordable Care Act. The Affordable Care Act could adversely impact the demand for Varex’s and its customers’ products and services, and therefore its financial position and results of operations, possibly materially. Changes in access to diagnostic radiology or the reimbursement rates associated with diagnostic radiology as a result of the Affordable Care Act and similar state proposals would likely affect domestic demand for Varex’s and Varex’s customers’ products and services.
In general, employers and third-party payors in the United States have become increasingly cost-conscious, with higher deductibles imposed or encouraged in many medical plans. The imposition of higher deductibles tends to restrain individuals from seeking the same level of medical treatments as they might seek if the costs they bear are lower, particularly in the medical diagnostic portion of Varex’s business. Third-party payors have also increased utilization controls related to the use of its products by healthcare providers.
Furthermore, there is no uniform policy on reimbursement among third-party payors, and Varex cannot be sure that third-party payors will reimburse its customers for procedures using its products that will enable it to achieve or maintain adequate sales and price levels for its products. Without adequate support from third-party payors, the market for Varex’s products may be limited.
Varex is unable to predict what effect new healthcare reform proposals or ongoing uncertainty surrounding foreign, federal and state health reform proposals will have on its customer’s purchasing decisions. However, an expansion in any government’s role in the healthcare industry may materially and adversely affect Varex’s business. In addition, it is possible that changes in administration and policy, including the potential repeal of all or parts of the Affordable Care Act, resulting from the recent U.S. presidential election could result in additional proposals and/or changes to health care system legislation, which could have a material adverse effect on our business. The full effect that a full or partial repeal of the Affordable Care Act would have on our business remains unclear at this time.
Varex is subject to federal, state and foreign laws governing its business practices which, if violated, could result in substantial penalties. Additionally, challenges to or investigations into Varex’s practices could cause adverse publicity and be costly to respond to and thus could harm its business.
Anti-corruption laws and regulations
. Varex is subject to the U.S. Foreign Corrupt Practices Act and anti-corruption laws, as well as similar laws in foreign countries, such as the U.K. Bribery Act and the Law “On the Fundamentals of Health Protection in the Russian Federation”. In general, there is a worldwide trend to strengthen anti-corruption laws and their enforcement, and the healthcare industry and medical equipment manufacturers have been particular targets of these investigation and enforcement efforts. Any violation of these laws by Varex or its agents or distributors could create a substantial liability for Varex, subject its officers and directors to personal liability and also cause a loss of reputation in the market. Transparency International’s 2015 Corruption Perceptions Index measured the degree to which public sector corruption is perceived to exist in 168 countries/territories around the world and found that two-thirds of the countries in the index, including many that Varex considers to be high-growth areas for Varex’s products, such as China and India, scored below 50 on a scale from 100 (very clean) to 0 (highly corrupt). Varex currently operates in many countries where the public sector is perceived as being more or highly corrupt. Varex’s strategic business plans include expanding its business in regions and countries that are rated as higher risk for corruption activity by Transparency International. Becoming familiar with and implementing the infrastructure necessary to comply with laws, rules and regulations applicable to new business activities and mitigating and protecting against corruption risks could be quite costly. In addition, failure by Varex or its agents or distributors to comply with these laws, rules and regulations could delay its expansion into high-growth markets and could materially and adversely affect its business. This notwithstanding, Varex will inevitably do more business, directly and potentially indirectly, in countries where the public sector is perceived to be more or highly corrupt and will be engaging in business in more countries perceived to be more or highly corrupt. Increased business in higher risk countries could subject Varex and its officers and directors to increased scrutiny and increased liability from its business operations.
Competition and trade compliance laws
. Varex is subject to various competition and trade compliance laws in the jurisdictions in which it operates. Regulatory authorities under whose laws Varex operates may have enforcement powers that can subject Varex to sanctions and can impose changes or conditions in the way Varex conducts its business. In addition, an increasing number of jurisdictions also provide private rights of action for competitors or consumers to seek damages asserting claims of anti-competitive conduct. Increased government scrutiny of Varex’s actions or enforcement or private rights of action could materially and adversely affect its business or damage its reputation. In addition, Varex may conduct, or it may be required to conduct, internal investigations or face audits or investigations by one or more domestic or foreign government agencies, which could be costly and time-consuming, and could divert its management and key personnel from its business operations. An adverse outcome under any such investigation or audit could subject Varex to fines or criminal or other penalties, which could materially and adversely affect Varex’s business and financial results. Furthermore, competition laws may prohibit or increase the cost of future acquisitions that Varex may desire to undertake.
Laws and ethical rules governing interactions with healthcare providers
. Generally, Varex does not sell its products directly to healthcare providers, although occasionally it may sell its products to healthcare providers through distributors. The U.S. Medicare and Medicaid “anti-kickback” laws, and similar state laws, prohibit payments or other remuneration that is intended to induce hospitals, physicians or others either to refer patients or to purchase, lease or order, or arrange for or recommend the purchase, lease or order of healthcare products or services for which payment may be made under federal and state healthcare programs, such as Medicare and Medicaid. These laws affect Varex’s sales, marketing and other promotional activities by limiting the kinds of financial arrangements Varex may have with hospitals, physicians or other potential purchasers of its products. They particularly impact how Varex structures its sales offerings, including discount practices, customer support, education and training programs, physician consulting, research grants and other fee-for-service arrangements. These laws are broadly written, and it is often difficult to determine precisely how these laws will be applied to specific circumstances.
Federal and state “false claims” laws generally prohibit knowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid or other government payors that are false or fraudulent, or for items or services that were not provided as claimed. Although Varex does not submit claims directly to payors, manufacturers can be, and have been, held liable under these laws if they are deemed to “cause” the submission of false or fraudulent claims by providing inaccurate billing or coding information to customers, or through certain other activities, including promoting products for uses not approved or cleared by the FDA, which is called off-label promotion. Violating “anti-kickback” and “false claims” laws can result in civil and criminal penalties, which can be substantial, as well as potential mandatory or discretionary exclusion from healthcare programs for noncompliance. Even an unsuccessful challenge or investigation into Varex’s practices could cause adverse publicity, and be costly to defend, and thus could harm its business and results of operations. Additionally, several recently enacted state and federal laws, including laws in Massachusetts and Vermont, and the federal Physician Payment Sunshine Act, now require, among other things, extensive tracking and maintenance of databases regarding the disclosure of equity ownership and payments to physicians, healthcare providers and hospitals. These laws may require Varex to implement the necessary and costly infrastructure to track and report certain payments to
healthcare providers. Failure to comply with these new tracking and reporting laws could subject Varex to significant civil monetary penalties.
Varex is subject to similar laws in foreign countries where it conducts business. For example, within the EU, the control of unlawful marketing activities is a matter of national law in each of the member states. The member states of the EU closely monitor perceived unlawful marketing activity by companies. Varex could face civil, criminal and administrative sanctions if any member state determines that Varex has breached its obligations under such state’s national laws. Industry associations also closely monitor the activities of member companies. If these organizations or authorities name Varex as having breached its obligations under their regulations, rules or standards, its reputation would suffer and its business and financial condition could be materially and adversely affected.
Warranty claims may materially and adversely affect Varex’s business.
Varex could experience an increase in warranty claims as a result of issues with product quality or product failures as a direct result of Varex’s design, manufacturing, or issues in its supply chain. Such an occurrence may damage Varex’s market reputation, cause sales to decline, or require repairs or voluntary remedial measures to enhance customer satisfaction, which could materially and adversely impact Varex’s financial results. Increased warranty claims on any given product could cause Varex to halt production on that product and could significantly impair Varex’s liquidity and profitability, as well as cause reputational harm to Varex. Because some categories of products tend to experience higher numbers of warranty claims than others, a shift in the types of products that Varex’s customers purchase could lead to an increase in warranty claims. If actual levels of warranty claims are greater than the level of claims Varex estimates, cost of sales could increase, and Varex’s financial condition could be materially and adversely affected. In addition, product quality issues could result in significant follow-on effects for Varex, including, among other things, reputational harm to Varex and its customers, loss of customers, and liability as a result of product quality issues. These outcomes would materially and adversely affect Varex’s business and financial condition.
If Varex is not able to match its manufacturing capacity with demand for its products, its financial results may suffer.
Many of Varex’s products have a long production cycle, and Varex needs to anticipate demand for its products to ensure adequate manufacturing or testing capacity. If Varex is unable to anticipate demand and its manufacturing or testing capacity does not keep pace with product demand, Varex will not be able to fulfill orders in a timely manner, which may negatively impact its financial results and overall business. Conversely, if demand for Varex’s products decreases, the fixed costs associated with excess manufacturing capacity may harm its financial results.
Additionally, Varex’s manufacturing is primarily conducted at its Salt Lake City, Utah; Las Vegas, Nevada and Calamba City, Philippines facilities. If any of these facilities experiences a disruption, Varex would have no other means of manufacturing the components manufactured at each respective facility until Varex is able to restore the capability at its current facilities or develop the same capability at an alternative facility.
Delivery schedules for Varex’s security, industrial and inspection products tend to be unpredictable.
Varex designs, manufactures, sells and services Linatron X-ray accelerators, image-processing software and image detection products for security and inspection, such as cargo screening at ports and borders and nondestructive examination for a variety of applications, as well as industrial applications. Varex generally sells security and inspection products to OEMs who incorporate its products into their inspection systems, which are then sold to customs and other government agencies, as well as to commercial organizations in the casting, power, aerospace, chemical, petro-chemical and automotive industries. Varex believes growth in its security and inspection products will be driven by security cargo screening and border protection needs, as well as by the needs of customs agencies to verify shipments for assessing duties and taxes. This business is heavily influenced by domestic and international government policies on border and port security, political change and government budgets. In addition, Varex believes growth in this product line may be driven in part by industrial customers engaged in 3-D printing, which, as a developing market, may be difficult to predict. Orders for Varex’s security and inspection products have been and may continue to be unpredictable as governmental agencies may place large orders with Varex or its OEM customers in a short time period, and then may not place any orders for a long time period thereafter. Because it is difficult to predict Varex’s OEM customer delivery, the actual timing of sales and revenue recognition varies significantly. The market for border protection systems has slowed significantly, and end customers, particularly in oil-based economies and war zones in which Varex has a significant customer base, are delaying system deployments or tenders and considering moving to alternative sources, resulting in a decline in the demand for security and inspection products.
In addition, demand for Varex’s security and inspection products is heavily influenced by U.S. and foreign governmental policies on national and homeland security, border protection and customs activities, which depend upon government budgets and appropriations that are subject to economic conditions, as well as political changes and oil prices. Varex has seen customers freeze or
dramatically reduce purchases and capital project expenditures, delay projects or act cautiously as governments around the world wrestle with spending priorities. As economic growth remains sluggish in various jurisdictions and appears to be deteriorating in others, and as concerns about levels of government employment and government debt continue, Varex expects that these effects will also continue. Furthermore, bid awards in this business may be subject to challenge by third parties, as Varex has previously encountered with a large government project. These factors make this business more unpredictable and could cause volatility in Varex’s revenues and earnings, and therefore the price of Varex’s common stock.
Varex’s international manufacturing operations subject it to volatility and other risks, including high security risks, which could result in harm to its employees and contractors or substantial costs.
Varex conducts certain manufacturing operations internationally in order to reduce costs and streamline its manufacturing operations. There are administrative, legal, and governmental risks to operating internationally that could increase operating expenses or hamper the development of these operations. The risks from operating internationally that could increase Varex’s operating expenses and materially and adversely affect its operating results, financial condition and ability to deliver its products and grow its business include, among others:
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difficulties in staffing and managing employee relations and foreign operations, particularly in attracting and retaining personnel qualified to design, sell, test and support its products;
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fluctuations in currency exchange rates;
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difficulties in coordinating its operations globally and in maintaining uniform standards, controls, procedures and policies across its operations;
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difficulties in enforcing contracts and protecting intellectual property;
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diversion of management attention;
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imposition of burdensome governmental regulations, including changing laws and regulations with respect to collection and maintenance of personally identifiable data;
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regional and country-specific political and economic instability, as discussed in greater detail below; and
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inadequacy of the local infrastructure to support its operations.
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In addition, Varex’s international locations expose it to high security risks, which could result in harm to its employees and contractors or substantial costs. Some of its services are performed in or adjacent to high-risk locations where the country or location and surrounding area is suffering from political, social or economic issues, war or civil unrest or has a high level of criminal or terrorist activity. In those locations where Varex has employees or operations, Varex may incur substantial costs to maintain the safety of its personnel. Despite these precautions, the safety of its personnel in these locations may continue to be at risk, and Varex may in the future suffer the loss of employees and contractors, which could harm its business and operating results.
Certain of Varex’s products are subject to regulations relating to use of radioactive material, compliance with which may be costly, and a failure to comply may materially and adversely affect Varex’s business.
As a manufacturer and seller of medical devices and devices emitting radiation or utilizing radioactive by-product material, Varex and some of Varex’s suppliers and distributors are subject to extensive regulation by United States governmental authorities, such as the FDA, the Nuclear Regulatory Commission (“NRC”) and state and local regulatory agencies, such as the State of California, to ensure the devices are safe and effective and comply with laws governing products which emit, produce or control radiation. These regulations govern, among other things, the design, development, testing, manufacturing, packaging, labeling, distribution, import/export, sale and marketing and disposal of Varex’s products. Varex is also subject to international laws and regulations that apply to manufacturers of radiation-emitting devices and products utilizing radioactive materials. These are often comparable to, if not more stringent than, the equivalent regulations in the United States.
Varex’s industrial and medical devices utilizing radioactive material are subject to NRC clearance and approval requirements, and the manufacture and sale of these products are subject to extensive federal and state regulation that varies from state to state and among regions. Varex’s manufacture, distribution, installation, service and removal of industrial devices utilizing radioactive material or emitting radiation also requires Varex to obtain a number of licenses and certifications for these devices and materials. Service of these products must also be in accordance with a specific radioactive materials license. Obtaining licenses and certifications may be time consuming, expensive and uncertain.
In addition, Varex is subject to a variety of environmental laws regulating its manufacturing operations and the handling, storage, transport and disposal of hazardous substances, and which impose liability for the cleanup of any contamination from these substances. In particular, the handling and disposal of radioactive materials resulting from the manufacture, use or disposal of Varex’s products may impose significant costs and requirements. Disposal sites for the lawful disposal of materials generated by the
manufacture, use or decommissioning of Varex’s products may no longer accept these substances in the future, or may accept them on unfavorable terms.
If Varex is unable to obtain required FDA clearances or approvals for a product or is unduly delayed in doing so, or the uses of that product were limited, Varex’s business could suffer.
Typically, Varex’s OEM customers are responsible for obtaining 510(k) pre-market notification clearance on their systems that integrate Varex products, the substantial majority of which are Class I devices. A small portion of Varex’s products, however, is software that is classified as a Class II device subject to 510(k) clearance. Unless an exception applies, Varex may be required by FDA regulations to obtain a 510(k) pre-market notification clearance in connection with the manufacture of a new medical device or a new indication for use of, or other significant change in, an existing currently marketed medical device before it can market or sell those products in the United States. Modifications or enhancements to a product that could significantly affect its safety or effectiveness, or that would constitute a major change in the intended use of the device, technology, materials, labeling, packaging or manufacturing process also require a new 510(k) clearance. Although manufacturers make the initial determination whether a change to a cleared device requires a new 510(k) clearance, Varex cannot assure you that the FDA will agree with its decisions not to seek additional approvals or clearances for particular modifications to its products or that Varex will be successful in obtaining new 510(k) clearances for modifications. Obtaining clearances or approvals is time-consuming, expensive and uncertain. Varex may not be able to obtain the necessary clearances or approvals or may be unduly delayed in doing so, which could harm its business. Furthermore, even if Varex is granted regulatory clearances or approvals, they may include significant limitations on the indicated uses of the product, which may limit the market for the product. If Varex is unable to obtain required FDA clearance or approval for a product or is unduly delayed in doing so, or the uses of that product were limited, Varex’s business could suffer.
Disruption of critical information systems or material breaches in the security of Varex’s products may materially and adversely affect its business and customer relations.
Information technology helps Varex operate efficiently, interface with and support its customers, maintain financial accuracy and efficiency and produce its financial statements. There is an increasing threat of information security attacks that pose risk to companies, including Varex. Because the techniques used to obtain unauthorized access, or to sabotage systems, change frequently and generally are not recognized until launched against a target, Varex may be unable to anticipate these techniques or to implement adequate preventative measures. If Varex does not allocate and effectively manage the resources necessary to build and sustain the proper technology infrastructure, Varex could be subject to, among other things, transaction errors, processing inefficiencies, the loss of customers, business disruptions or the loss of or damage to intellectual property through a security breach or misappropriation of intellectual property. Such security breaches could expose Varex to a risk of loss of information, litigation and possible liability to employees, customers and regulatory authorities. If Varex’s data management systems do not effectively collect, secure, store, process and report relevant data for the operation of its business, whether due to equipment malfunction or constraints, software deficiencies, or human error, Varex’s ability to effectively plan, forecast and execute its business plan and comply with applicable laws and regulations will be impaired, perhaps materially. Any such impairment could materially and adversely affect Varex’s financial condition, results of operations, cash flows and the timeliness with which Varex reports its operating results internally and externally.
Moreover, Varex offers cloud-based training software. A security breach, whether of Varex’s products, of Varex’s customers’ network security and systems or of third party hosting services could disrupt access to Varex’s customers’ stored information and could lead to the loss of, damage to or public disclosure of Varex’s customers’ stored information, including patient health information. Such an event could have serious negative consequences, including possible patient injury, regulatory action, fines, penalties and damages, reduced demand for Varex’s solutions, an unwillingness of its customers to use its solutions, harm to its reputation and brand, and time-consuming and expensive litigation, any of which could have a material and adverse effect on Varex’s financial results.
Protecting Varex’s intellectual property can be costly, and Varex may not be able to maintain licensed rights, and in either case, its competitive position would be harmed if Varex is not able to do so.
Varex files applications as appropriate for patents covering new products and manufacturing processes. Varex cannot be sure, however, that its current patents, the claims allowed under its current patents or patents for technologies licensed to Varex will be sufficiently broad to protect its technology position against competitors. Issued patents owned by, or licensed to, Varex may be challenged, invalidated or circumvented, or the rights granted under the patents may not provide Varex with competitive advantages. Varex also cannot be sure that patents will be issued from any of Varex’s pending or future patent applications. Asserting Varex’s patent rights against others in litigation or other legal proceedings is costly and diverts managerial resources. In addition, Varex may not be able to detect patent infringement by others or may lose its competitive position in the market before Varex is able to do so.
Varex also relies on a combination of copyright, trade secret and other laws, and contractual restrictions on disclosure, copying and transferring title (including confidentiality agreements with vendors, strategic partners, co-developers, employees, consultants and
other third parties), to protect its proprietary and other confidential rights. These protections may prove to be inadequate, since agreements may still be breached, Varex may not have adequate remedies for a breach, and its trade secrets may otherwise become known to or be independently developed by others, including as a result of misappropriation by unauthorized access to Varex’s technology systems. In the event that Varex’s proprietary or confidential information is misappropriated, its business and financial results could be materially and adversely impacted. Varex has trademarks, both registered and unregistered, that are maintained and enforced to provide customer recognition for its products in the marketplace, but unauthorized third parties may still use them. Varex also has agreements with third parties that license to Varex certain patented or proprietary technologies. In some cases, products with substantial revenues may depend on these license rights. If Varex were to lose the rights to license these technologies, or its costs to license these technologies were to materially increase, its business would suffer.
Third parties may claim that Varex is infringing upon their intellectual property, and Varex could suffer significant litigation or licensing expenses or be prevented from selling its products.
There is a substantial amount of litigation over patent and other intellectual property rights in the industries in which Varex competes. Varex’s competitors, like companies in many high technology businesses, continually review other companies’ activities for possible conflicts with their own intellectual property rights. In addition, non-practicing entities may review Varex’s activities for conflicts with their patent rights. Determining whether a product infringes upon a third party’s intellectual property rights involves complex legal and factual issues, and the outcome of this type of litigation is often uncertain. Third parties may claim that Varex is infringing upon their intellectual property rights. Varex may not be aware of intellectual property rights of others that relate to its products, services or technologies. From time to time, Varex has received notices from third parties asserting infringement and Varex has been subject to lawsuits alleging infringement of third-party patent or other intellectual property rights. Any dispute regarding patents or other intellectual property could be costly and time consuming, and could divert Varex’s management and key personnel from its business operations. Varex may not prevail in a dispute. Varex does not maintain insurance for intellectual property infringement, so costs of defense, whether or not Varex is successful in defending an infringement claim, will be borne by Varex and could be significant. If Varex is unsuccessful in defending or appealing an infringement claim, Varex may be subject to significant damages, and its combined financial position, results of operations or cash flows could be materially and adversely affected. If actual liabilities significantly exceed its estimates regarding potential liabilities, its combined financial position, results of operations or cash flows could be materially and adversely affected. Varex may also be subject to injunctions against development and sale of its products, the effect of which could be to materially reduce its revenues. Furthermore, a third party claiming infringement may not be willing to license its rights to Varex, and even if a third-party rights holder is willing to do so, the amounts Varex might be required to pay under the associated royalty or license agreement could be significant. As such, Varex could decide to alter its business strategy or voluntarily cease the allegedly infringing actions rather than face litigation or pay a royalty, which could materially and adversely impact its business and results of operations.
Product defects or misuse may result in material product liability or professional errors and omissions claims, litigation, investigation by regulatory authorities or product recalls that could harm Varex’s future revenues and require it to pay material uninsured claims.
Varex’s business exposes it to potential product liability claims that are inherent in the manufacture, sale, installation, servicing and support of components that are used in medical devices and other devices that deliver radiation. Because Varex’s products, through incorporation in OEMs’ systems, are involved in the intentional delivery of radiation to the human body and other situations where people may come into contact with radiation (for example, when Varex’s security and inspection products are being used to scan cargo and diagnosis of medical problems), the possibility for significant injury and/or death exists to the intended or unintended recipient of the delivery. In addition, although Varex’s products are incorporated into OEMs’ systems, and thus only perform pursuant to the design and operating systems of OEMs, Varex may also be subject to claims for property damage, personal injury or economic loss related to or resulting from any errors or defects in its products or the installation, servicing and support of its products. Any accident or mistreatment could subject Varex to legal costs, litigation, adverse publicity and damage to its reputation, whether or not its products or services were a factor.
If Varex’s X-ray inspection systems fail to detect the presence of bombs, explosives, weapons, contraband or other threats to personal safety, Varex could be subject to product and other liability claims and negative publicity, which could result in increased costs, reduced sales and a decline in the market price of Varex’s common stock. There are many factors beyond Varex’s control that could result in the failure of its products to detect the presence of bombs, explosives, weapons, contraband or other threats to personal safety. Examples of these factors include operator error or misuse of or malfunction of Varex equipment. The failure of Varex’s systems to detect the presence of these dangerous materials may lead to personal injury, loss of life, and extensive property damage and may result in potential claims against Varex.
Product liability actions are subject to significant uncertainty and may be expensive, time-consuming and disruptive to Varex’s operations. For these and other reasons, Varex may choose to settle product liability claims against it, regardless of their actual
merit. If a product liability action were finally determined against Varex, it could result in adverse publicity or significant damages, including the possibility of punitive damages, and Varex’s combined financial position, results of operations or cash flows could be materially and adversely affected.
In addition, if a product Varex designs or manufactures were defective (whether due to design, labeling or manufacturing defects, improper use of the product or other reasons) or found to be so by a competent regulatory authority, Varex may be required to correct or recall the product and notify other regulatory authorities. The adverse publicity resulting from a correction or recall, however imposed, could damage Varex’s reputation and cause customers to review and potentially terminate their relationships with Varex. A product correction or recall could consume management time and have an adverse financial impact on its business, including incurring substantial costs, losing revenues and accruing losses under GAAP.
Varex maintains limited product liability insurance coverage and currently self-insures professional liability/errors and omissions liability. Varex’s product liability insurance policies are expensive and have high deductible amounts and self-insured retentions. Varex’s insurance coverage may also prove to be inadequate, and future policies may not be available on acceptable terms or in sufficient amounts, if at all. If a material claim is successfully brought against Varex relating to a self-insured liability or a liability that is in excess of its insurance coverage, or for which insurance coverage is denied or limited, Varex could have to pay substantial damages, which could have a material and adverse effect on its financial position and results of operations.
Unfavorable results of legal proceedings could materially and adversely affect Varex’s financial results.
From time to time, Varex 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. Legal proceedings are often lengthy, taking place over a period of years with interim motions or judgments subject to multiple levels of review (such as appeals or rehearings) before the outcome is final. Litigation is subject to significant uncertainty and may be expensive, time-consuming, and disruptive to Varex’s operations. For these and other reasons, Varex may choose to settle legal proceedings and claims, regardless of their actual merit.
If a legal proceeding were finally resolved against Varex, it could result in significant compensatory damages, and, in certain circumstances, punitive or treble damages, disgorgement of revenue or profits, remedial corporate measures or injunctive relief imposed on Varex. If Varex’s existing insurance does not cover the amount or types of damages awarded, or if other resolution or actions taken as a result of the legal proceeding were to restrain its ability to market one or more of its material products or services, its combined financial position, results of operations or cash flows could be materially and adversely affected. In addition, legal proceedings, and any adverse resolution thereof, can result in adverse publicity and damage to Varex’s reputation, which could materially and adversely impact its business.
Varex’s business may suffer if it is not able to hire and retain qualified personnel.
Varex’s future success depends, to a great degree, on its ability to retain, attract, expand, integrate and train its management team and other key personnel, such as qualified engineering, service, sales, marketing and other staff. Varex competes for key personnel with other medical equipment and software manufacturers and technology companies, as well as universities and research institutions. Because this competition is intense, particularly in Utah, where unemployment rates are relatively low, compensation-related costs could increase significantly if the supply of qualified personnel decreases or demand increases. If Varex is unable to hire and train qualified personnel, Varex may not be able to maintain or expand its business. Additionally, if Varex is unable to retain key personnel, Varex may not be able to replace them readily or on terms that are reasonable, which also could hurt its business.
Varex may be unable to complete future acquisitions or realize expected benefits from acquisitions of or investments in new businesses, products or technologies, which could harm Varex’s business.
Varex’s ability to identify and take advantage of attractive acquisitions or other business development opportunities is an important component in implementing its overall business strategy. Varex needs to grow Varex’s businesses in response to changing technologies, customer demands and competitive pressures. In some circumstances, Varex may decide to grow its business through the acquisition of complementary businesses, products or technologies rather than through internal development. For example, during fiscal year 2015, Varex acquired Claymount and MeVis. In addition, in January 2017, Varex succeeded in Varian’s interest to purchase the medical imaging business of PerkinElmer, Inc. (“PerkinElmer”) for $276 million, as forth in a Master Purchase and Sale Agreement (the “MPSA”) between Varian and PerkinElmer dated as of December 21, 2017 (the “PerkinElmer Acquisition”). The PerkinElmer Acquisition is expected to close in 2017.
Identifying suitable acquisition candidates can be difficult, time-consuming and costly, and Varex may not be able to identify suitable candidates or successfully complete or finance identified acquisitions, including as a result of failing to obtain regulatory or competition clearances, which could impair Varex’s growth and ability to compete. In addition, completing an acquisition can divert
Varex’s management and key personnel from its current business operations, which could harm its business and affect its financial results. Even if Varex completes an acquisition, Varex may not be able to successfully integrate newly-acquired organizations, products, technologies or employees into its operations, or may not fully realize some of the expected synergies.
Integrating an acquisition can also be expensive and time-consuming, and may strain Varex’s resources. It may cost Varex more to commercialize new products than originally anticipated or cause Varex to increase its expenses related to research and development, either of which could materially and adversely impact its results of operations. In many instances, integrating a new business will also involve implementing or improving internal controls appropriate for a public company into a business that lacks them. It is also possible that an acquisition could increase Varex’s risk of litigation, as a third party may be more likely to assert a legal claim following an acquisition because of perceived deeper pockets or perceived greater value of a claim. In addition, Varex may be unable to retain the employees of acquired companies, or the acquired company’s customers, suppliers, distributors or other partners for a variety of reasons, including the fact that these entities may be Varex’s competitors or may have close relationships with its competitors.
Further, Varex may find that it needs to restructure or divest acquired businesses, or assets of those businesses. Even if it does so, an acquisition may not produce the full efficiencies, growth or benefits that were expected. If Varex decides to sell assets or a business, it may be difficult to identify buyers or alternative exit strategies on acceptable terms, in a timely manner or at all, which could delay the accomplishment of its strategic objectives. Varex may be required to dispose of a business at a lower price or on less advantageous terms, or to recognize greater losses than it had anticipated.
If Varex acquires a business, it allocates the total purchase price to the acquired businesses’ tangible assets and liabilities, identifiable intangible assets and liabilities based on their fair values as of the date of the acquisition and record the excess of the purchase price over those fair values as goodwill. If it fails to achieve the anticipated growth from an acquisition, or if it decides to sell assets or a business, it may be required to recognize an impairment loss on the write down of its assets and goodwill, which could materially and adversely affect its financial results. In addition, acquisitions can result in potentially dilutive issuances of equity securities or the incurrence of debt, contingent liabilities or expenses, or other charges, any of which could harm Varex’s business and affect its financial results.
Additionally, Varex has investments in privately held companies (for example, dpiX LLC) that are subject to risk of loss of investment capital. These investments are inherently risky, in some instances because the markets for the technologies or products these companies have under development may never materialize. If these companies do not succeed, Varex could lose some or all of its investment in these companies.
Varex may face additional risks from the acquisition or development of new lines of business.
From time to time, Varex may acquire or develop new lines of business. There are substantial risks and uncertainties associated with new lines of business, particularly in instances where the markets are not fully developed. Risks include developing knowledge of and experience in the new business, recruiting market professionals, increasing research and development expenditures and developing and capitalizing on new relationships with experienced market participants. This may mean significant investment and involvement of Varex’s senior management to acquire or develop, then integrate, the business into its operations. Timelines for integration of new businesses may not be achieved, and price and profitability targets may not prove feasible, as new products can carry lower gross margins than existing products. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences may also impact whether implementation of a new business will be successful. Failure to manage these risks could have a material and adverse effect on its business, results of operations and financial condition.
The proposed acquisition of PerkinElmer’s medical imaging business may not be consummated.
In connection with the separation and distribution, Varian assigned the MPSA to Varex. Varex cannot provide any assurances that the proposed transaction with PerkinElmer will be consummated. If Varex is unable to complete the proposed transaction, it will have incurred substantial expenses and diverted significant management time and resources from its ongoing business without the intended benefit. For more information about the proposed acquisition of PerkinElmer Acquisition, see the section entitled “Business-Acquisition of PerkinElmer’s Medical Imaging Business” in Varex’s Information Statement, which was included as Exhibit 99.1 to Varex’s Current Report on 8-K filed with the U.S. Securities and Exchange Commission on January 20, 2017 (the “Information Statement”).
Varex’s obligation to consummate the acquisition of PerkinElmer’s medical imaging business is not subject to any financing contingency, and failure to obtain the necessary financing to consummate the acquisition would result in a material adverse effect on Varex.
In connection with the separation and distribution, Varex assumed all of the rights and obligations of Varian under the MPSA. Varex intends to obtain third-party debt financing to finance all or a substantial portion of the purchase price to consummate the PerkinElmer Acquisition. However, the obligation of Varex to consummate the PerkinElmer Acquisition is not subject to any financing contingency.
While Varex expects that it will be able to raise the necessary financing, and has received a commitment letter to that effect, there can be no assurance that Varex will be able to do so. Varex’s ability to raise the necessary financing will be subject to, among other things, market conditions and the performance of Varex and PerkinElmer’s medical imaging business. Assuming the satisfaction of the conditions to closing in the MPSA, Varex will be obligated to close the acquisition of PerkinElmer Acquisition whether or not it has obtained the necessary financing, and if Varex fails to obtain the necessary financing, Varex may need to sell assets or otherwise raise funds to finance the acquisition. In the event that the conditions to closing in the MPSA are satisfied, and Varex is unable to raise the necessary financing to close the acquisition, Varex could face litigation from PerkinElmer alleging breach of the MPSA. If Varex were found to be in breach of the MPSA, Varex could be ordered to specifically perform the MPSA or pay damages to PerkinElmer. Varex may be unable to pay any damage award or specifically perform the contract, which could have a material adverse effect on Varex.
Varex’s credit facilities do not permit the financing needed to finance the acquisition of PerkinElmer Acquisition. In order to finance the PerkinElmer Acquisition, Varex will be required to refinance its credit facilities to permit such acquisition. However, there can be no assurance that Varex will be able to refinance its credit facilities on favorable terms or at all. Failure to refinance its credit facilities on favorable terms or at all could have a material adverse effect on Varex.
Certain governmental authorities may seek to impose material restrictions or conditions on its approval of the PerkinElmer Acquisition.
Following the separation and distribution and the assignment by Varian of the MPSA to Varex, Varex became subject to regulatory risks relating to the proposed PerkinElmer Acquisition. Each of the Antitrust Division of the U.S. Department of Justice or the Federal Trade Commission could take actions under the antitrust laws as it deems necessary or desirable in the public interest, including seeking to enjoin the consummation of the transactions or seeking divestiture of substantial assets of Varex or PerkinElmer’s medical imaging business. In addition, any state of the U.S. or certain foreign governmental authorities could take such actions under applicable antitrust laws as it deems necessary and desirable, including seeking to enjoin the consummation of the transactions or seeking divestiture of substantial assets of Varex or PerkinElmer’s medical imaging business. As described below, while Varex is not obligated to agree to divestitures or other restrictions on Varex’s or PerkinElmer’s medical imaging business in order to obtain antitrust clearance, there can be no assurance that it would not voluntarily agree to take certain actions to obtain antitrust approval. If the PerkinElmer Acquisition is not consummated due to the failure to obtain antitrust clearance, Varex may be obligated to pay a reverse termination fee to PerkinElmer as described below.
Following the closing of the transactions contemplated by the Master Purchase and Sale Agreement, the acquired business may not achieve strategic objectives, anticipated synergies and/or other expected potential benefits.
Varex expects to realize strategic and other financial and operating benefits as a result of the transactions contemplated by the MPSA. However, Varex cannot predict with certainty the extent to which these benefits will actually be achieved or the timing of any such benefits. The following factors, among others, may prevent Varex from realizing these benefits:
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the inability of the acquired business to increase product sales;
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unfavorable customer reaction to the transaction or Varex’s products following the closing;
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competitive factors, including technological advances attained by competitors or the decision of certain companies currently engaged in the industrial sector to compete in the medical imaging sector;
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the failure of key markets for Varex’s products to develop to the extent or as rapidly as currently expected;
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changes in technology that require Varex to make significant capital expenditures to develop competitive products;
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employment laws or regulations or other limitations in foreign jurisdictions, or other operational issues, that could have an impact on the timing or amount of synergies; and
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the failure to retain key employees.
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Failure to achieve the strategic objectives of the transaction could have a material adverse effect on the revenues, expenses and the operating results and cash resources of Varex and could result in Varex not achieving the anticipated potential benefits of the transaction. In addition, there is no assurance that the growth rate of the acquired business will equal the historical growth rate experienced by PerkinElmer.
Varex may not successfully integrate its business with the business acquired from PerkinElmer.
Achieving the potential benefits of the transaction with PerkinElmer will depend in substantial part on the successful integration of the technologies, operations and personnel of the acquired business. Varian may face challenges integrating PerkinElmer’s medical imaging business, including:
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consolidating and rationalizing corporate information technology, engineering and administrative infrastructures;
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integrating product offerings;
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coordinating sales and marketing efforts;
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coordinating and integrating the manufacturing activities of the acquired business; and
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coordinating and rationalizing research and development activities to enhance introduction of new products and technologies with reduced cost.
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The integration of PerkinElmer’s medical imaging business will be a complex, time-consuming and expensive process. It is not certain that PerkinElmer’s medical imaging business can be successfully integrated in a timely manner, in a cost-efficient manner or at all. Failure to do so could have a material adverse effect on the revenues, expenses and the operating results and cash resources of Varex and could result in Varex not achieving the anticipated potential benefits of the transaction.
Integrating the PerkinElmer medical imaging business may divert management’s attention away from our operations.
Successful integration of PerkinElmer’s medical imaging business operations, products and personnel may place a significant burden on Varex’s management and its internal resources following the completion of the transaction. The diversion of management attention and any difficulties encountered in the transition and integration process could harm Varex’s business, financial condition, operating results and evaluation of strategic actions.
If Varex fails to retain key employees, the benefits of the acquisition of PerkinElmer’s medical imaging business could be diminished.
The success of Varex’s acquisition of PerkinElmer’s medical imaging business will depend in part on the retention of key personnel. There can be no assurance that Varex will be able to retain its or PerkinElmer’s key management, technical, sales and customer support personnel related to the acquired business. If such key employees are not retained, Varex may not realize the anticipated benefits of the transaction.
Sales could decline if customer relationships are disrupted by the proposed acquisition of PerkinElmer’s medical imaging business.
Varex’s and PerkinElmer’s customers may not continue their current buying patterns during the pendency of, and following, the PerkinElmer Acquisition. Any loss of design wins or significant delay or reduction in orders for Varex’s or PerkinElmer’s products could harm Varex’s business, financial condition and results of operations following the closing. Customers may defer purchasing decisions as they evaluate the likelihood of successful integration of PerkinElmer’s and Varex’s medical imaging products or consider purchasing products of our competitors. Customers may also seek to modify or terminate existing agreements, and prospective customers may delay entering into new agreements or purchasing our products.
As a result of the proposed PerkinElmer Acquisition, Varex will be a larger and more geographically-diverse organization, and if Varex’s management is unable to manage the combined organization efficiently, its operating results will suffer.
Following the PerkinElmer Acquisition, Varex will face challenges inherent in efficiently managing an increased number of employees over large geographic distances, including with respect to implementing appropriate systems, policies, benefits and compliance programs. The inability to manage successfully the geographically more diverse and larger combined organization could have a material adverse effect on the operating results of Varex after the transaction and, as a result, on the market price of Varex’s common stock.
Fluctuations in Varex’s operating results, including quarterly revenues, and margins, may cause its stock price to be volatile, which could cause losses for its stockholders.
Varex has experienced and expects in the future to experience fluctuations in its operating results, including revenues and margins, from period to period.
Varex’s quarterly operating results, including its revenues and margins, may be affected by a number of other factors, including:
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the introduction and timing of announcement of new products or product enhancements by Varex and its competitors;
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change in its or its competitors’ pricing or discount levels;
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changes in foreign currency exchange rates and other economic uncertainty;
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changes in the relative portion of its revenues represented by its various products, including the relative mix between higher margin and lower-margin products;
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changes in the relative portion of its revenues represented by its international region as a whole and by regions within the overall region, as well as by individual countries (notably, those in emerging markets);
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fluctuation in its effective tax rate, which may or may not be known to Varex in advance;
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the availability of economic stimulus packages or other government funding, or reductions thereof;
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disruptions in the supply or changes in the costs of raw materials, labor, product components or transportation services;
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changes to its organizational structure, which may result in restructuring or other charges;
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disruptions in its operations, including its ability to manufacture products, caused by events such as earthquakes, fires, floods, terrorist attacks or the outbreak of epidemic diseases;
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the unfavorable outcome of any litigation or administrative proceeding or inquiry, as well as ongoing costs associated with legal proceedings; and,
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accounting changes and adoption of new accounting pronouncements.
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Because many of Varex’s operating expenses are based on anticipated capacity levels, and a high percentage of these expenses are fixed for the short term, a small variation in the timing of revenue recognition can cause significant variations in operating results from quarter to quarter. If Varex’s gross margins fall below the expectation of securities analysts and investors, the trading price of Varex common stock would almost certainly decline.
In addition, as discussed in more detail elsewhere in this Quarterly Report, significant changes may occur in Varex’s cost structure, management, financing and business operations as a result of operating as a company separate from Varian.
Varex to entered into a secured revolving credit facility and a secured term loan credit facility in connection with the separation, each of which restricts certain activities, and failure to comply with these facilities may have an adverse effect on its business, liquidity and financial position.
Varex entered into a secured revolving credit facility and a secured term loan credit facility in connection with the separation, each of which contains restrictive financial covenants, including financial covenants that require Varex to comply with specified financial ratios. Varex may have to curtail some of its operations to comply with these covenants. In addition, its credit facilities contain other affirmative and negative covenants that could restrict its operating and financing activities. These provisions will limit its ability to, among other things, incur future indebtedness, contingent obligations or liens, guarantee indebtedness, make certain investments and capital expenditures, sell stock or assets and pay dividends and consummate certain mergers or acquisitions. If Varex fails to comply with the credit facility requirements, it may be in default. Upon an event of default, if the Credit Agreement is not amended or the event of default is not waived, the lender could declare all amounts then outstanding, together with accrued interest, to be immediately due and payable. If this happens, Varex may not be able to make those payments or borrow sufficient funds from alternative sources to make those payments. Even if Varex were to obtain additional financing, that financing may be on unfavorable terms.
In connection with the separation, Varex incurred debt obligations that could adversely affect Varex’s business, profitability and ability to meet its obligations.
As of December 30, 2016, on a pro forma basis after giving effect to the new financing arrangements that Varex entered into in connection with the separation and after giving effect to the application of the net proceeds of such financing, Varex’s total combined indebtedness was $203.0 million.
This debt could potentially have important consequences to Varex and its debt and equity investors, including:
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requiring that a portion of Varex’s cash flow from operations be used to make interest payments on this debt following the separation, which would reduce cash flow available for other corporate purposes;
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increasing Varex’s vulnerability to shifts in interest rates and to general adverse economic and industry conditions;
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limiting Varex’s flexibility in planning for, or reacting to, changes in its business and the industry; and,
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limiting Varex’s ability to borrow additional funds as needed, or increasing the costs of any such borrowing.
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To the extent that Varex incurs additional indebtedness, including in connection with consummating the acquisition of PerkinElmer’s medical imaging business, the foregoing risks could increase. In addition, Varex’s actual cash requirements in the future may be greater than expected. Varex’s cash flow from operations may not be sufficient to repay all of the outstanding debt as it
becomes due, and Varex may not be able to borrow money, sell assets or otherwise raise funds on acceptable terms, or at all, to refinance Varex’s debt.
Changes in interpretation or application of generally accepted accounting principles may materially and adversely affect Varex’s operating results.
Varex prepares its financial statements to conform to GAAP. These principles are subject to interpretation by the FASB, American Institute of Certified Public Accountants, the SEC and various other regulatory or accounting bodies. A change in interpretations of, or its application of, these principles can have a significant effect on Varex’s reported results and may even affect its reporting of transactions completed before a change is announced. In addition, when Varex is required to adopt new accounting standards, Varex’s methods of accounting for certain items may change, which could cause its results of operations to fluctuate from period to period and make it more difficult to compare its financial results to prior periods.
As its operations evolve over time, Varex may introduce new products or new technologies that require Varex to apply different accounting principles, including ones regarding revenue recognition, than Varex has applied in past periods. The application of different types of accounting principles and related potential changes may make it more difficult to compare its financial results from quarter to quarter, and the trading price of Varex common stock could suffer or become more volatile as a result.
Environmental laws impose compliance costs on its business and can also result in liability.
Varex is subject to environmental laws around the world. These laws regulate many aspects of its operations, including its handling, storage, transport and disposal of hazardous substances, such as the chemicals and materials that Varex uses in the course of its manufacturing operations. They can also impose cleanup liabilities, including with respect to discontinued operations. As a consequence, Varex can incur significant environmental costs and liabilities, some recurring and others not recurring. Although Varex follows procedures intended to comply with existing environmental laws, Varex, like other businesses, may mishandle or inadequately manage hazardous substances used in its manufacturing operations and can never completely eliminate the risk of contamination or injury from certain materials that Varex uses in its business and, therefore, the prospect of resulting claims and damage payments. Varex may also be assessed fines or penalties for failure to comply with environmental laws and regulations. Insurance has provided coverage for portions of cleanup costs resulting from historical occurrences, but Varex does not expect to maintain insurance coverage for costs or claims that might result from any future contamination.
Future changes in environmental laws could also increase its costs of doing business, perhaps significantly. Several countries, including some in the EU, now require medical equipment manufacturers to bear certain disposal costs of products at the end of the product’s useful life, increasing its costs. The EU has also adopted directives that may lead to restrictions on the use of certain hazardous substances or other regulated substances in some of its products sold there. These directives, along with another that requires substance information to be provided upon request, could increase its operating costs in order to maintain access to certain markets. All of these costs, and any future violations or liabilities under environmental laws or regulations, could have a material adverse effect on its business.
Varex’s operations are vulnerable to interruption or loss due to natural or other disasters, power loss, strikes and other events beyond its control.
Varex conducts some of its activities, including manufacturing, research and development, administration and data processing at facilities located in areas that have in the past experienced or may in the future experience natural disasters. Varex’s insurance coverage for such disasters may not be adequate or continue to be available at commercially reasonable terms, or at all. A major disaster (such as a major fire, hurricane, earthquake, flood, tsunami, volcanic eruption or terrorist attack) affecting Varex’s facilities, or those of its suppliers, could significantly disrupt its operations, and delay or prevent product manufacture and shipment during the time required to repair, rebuild or replace its or its suppliers’ damaged manufacturing facilities. These delays could be lengthy and costly. If any of its customers’ facilities are adversely affected by a disaster, shipments of its products could be delayed. Additionally, customers may delay purchases of its products until operations return to normal. For example, following the earthquake and tsunami disasters in Japan in 2011, Toshiba’s operations were impacted and, as a consequence, orders to and product shipment from the Imaging Components business were delayed for several months. Even if Varex is able to quickly respond to a disaster, the ongoing effects of the disaster could create some uncertainty in the operations of its businesses. In addition, its facilities may be subject to a shortage of available electrical power and other energy supplies. Any shortages may increase its costs for power and energy supplies or could result in blackouts, which could disrupt the operations of its affected facilities and harm its business. Further, its products are typically shipped from a limited number of ports, and any disaster, strike or other event blocking shipment from these ports could delay or prevent shipments and harm its business. In addition, concerns about terrorism, the effects of a terrorist attack, political turmoil or an outbreak of epidemic diseases, such as Ebola, severe acute respiratory syndrome (SARS) or avian flu virus, could have a negative effect on its business operations, those of its suppliers and customers, and the ability to travel, resulting in adverse consequences on Varex’s revenues and financial performance.
Risks Related to the Separation
V
arex had no history of operating as an independent company, and its historical financial information is not necessarily representative of the results that it would have achieved as a separate, publicly-traded company and may not be a reliable indicator of its future results.
The historical information about Varex in this Quarterly Report refers to Varex’s business as operated by and integrated with Varian. Varex’s historical financial information included in this Quarterly Report is derived from the consolidated financial statements and accounting records of Varian. Accordingly, the historical financial information included in this Quarterly Report statement does not necessarily reflect the financial condition, results of operations or cash flows that Varex would have achieved as a separate, publicly-traded company during the periods presented or those that Varex will achieve in the future primarily as a result of the factors described below:
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Prior to the separation, Varex’s business was operated by Varian as part of its broader corporate organization, rather than as an independent company. Varian or one of its affiliates performed various corporate functions for Varex such as accounting, legal, human resources, information technology, treasury, tax, facilities, research and development, insurance and other corporate and infrastructure services. Varex’s historical financial results reflect allocations of corporate expenses from Varian for such functions and are likely to be less than the expenses Varex would have incurred had it operated as a separate publicly traded company. Following the separation, Varex’s costs related to such functions previously performed by Varian may therefore increase.
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Prior to the separation, Varex’s business was integrated with the other businesses of Varian. Historically, Varex has shared economies of scope and scale in costs, employees, vendor relationships and customer relationships. Although Varex entered into a Transition Services Agreement with Varian, the arrangements provided by such agreement may not fully capture the benefits that Varex has enjoyed as a result of being integrated with Varian and may result in Varex paying higher charges than in the past for these services. This could have a material and adverse effect on Varex’s results of operations and financial condition.
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Generally, Varex’s working capital requirements and capital for its general corporate purposes, including acquisitions and capital expenditures, have historically been satisfied as part of the corporate-widecash management policies of Varian. Following the separation, Varex may need to obtain additional financing from banks, through public offerings or private placements of debt or equity securities, strategic relationships or other arrangements, which may or may not be available and may be more costly.
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After the completion of the separation, the cost of capital for Varex’s business is expected to be higher than Varian’s cost of capital prior to the separation.
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Other significant changes are likely to occur in Varex’s cost structure, management, financing and business operations as a result of operating as a company separate from Varian, including as a result of additional costs that will be incurred by Varex as a result of the separation.
Potential indemnification liabilities to Varian pursuant to the Separation and Distribution Agreement could materially and adversely affect Varex’s business, financial condition, results of operations and cash flows.
The Separation and Distribution Agreement provides for, among other things, indemnification obligations designed to make Varex financially responsible for: any Varex liabilities; the failure of Varex to pay, perform or otherwise promptly discharge any Varex liabilities or contracts, in accordance with their respective terms; any guarantee, indemnification obligation, surety bond or other credit support agreement, arrangement, commitment or understanding by Varian for the benefit of Varex, unless related to Varian liabilities; any breach by Varex of the Separation and Distribution Agreement or any of the ancillary agreements or any action by Varex in contravention of its amended and restated certificate of incorporation or amended and restated bylaws; and any untrue statement or alleged untrue statement of a material fact or omission or alleged omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading, with respect to all information contained in the registration statement on Form 10 (as amended or supplemented) or any other disclosure document that describes the separation or the distribution or Varex and its subsidiaries or primarily relates to the transactions contemplated by the Separation and Distribution Agreement, subject to certain exceptions. If Varex is required to indemnify Varian under the circumstances set forth in the Separation and Distribution Agreement, Varex may be subject to substantial liabilities.
In connection with Varex’s separation from Varian, Varian has agreed to indemnify Varex for certain liabilities. However, there can be no assurance that the indemnity will be sufficient to insure Varex against the full amount of such liabilities or that Varian’s ability to satisfy its indemnification obligation will not be impaired in the future.
Pursuant to the Separation and Distribution Agreement and certain other agreements with Varian, Varian agreed to indemnify Varex for certain liabilities. However, third parties could also seek to hold Varex responsible for any of the liabilities that Varian
retained, and there can be no assurance that the indemnity from Varian will be sufficient to protect Varex against the full amount of such liabilities or that Varian will be able to fully satisfy its indemnification obligations. In addition, Varian’s insurers may attempt to deny coverage to Varex for liabilities associated with certain occurrences of indemnified liabilities prior to the separation. Moreover, even if Varex ultimately succeeds in recovering from Varian or such insurance providers any amounts for which Varex is held liable, Varex may be temporarily required to bear these losses. Each of these risks could negatively affect Varex’s business, financial position, results of operations and cash flows.
If the distribution, together with certain related transactions, does not qualify as a transaction that is generally tax-free for U.S. federal income tax purposes, Varian, Varex and Varian stockholders could be subject to significant tax liabilities, and, in certain circumstances, Varex could be required to indemnify Varian for material taxes and other related amounts pursuant to indemnification obligations under the Tax Matters Agreement.
It was a condition to the distribution that Varian receive an opinion of counsel, satisfactory to the Varian board of directors, regarding the qualification of the distribution, together with certain related transactions, as a transaction that is generally tax-free for U.S. federal income tax purposes under Sections 355 and 368(a)(1)(D) of the Code. The opinion of counsel was based upon and relied on, among other things, certain facts and assumptions, as well as certain representations, statements and undertakings of Varian and Varex, including those relating to the past and future conduct of Varian and Varex. If any of these representations, statements or undertakings are, or become, inaccurate or incomplete, or if Varian or Varex breaches any of its covenants in the separation documents, the opinion of counsel may be invalid and the conclusions reached therein could be jeopardized. Notwithstanding the opinion of counsel, the Internal Revenue Service (the “IRS”) could determine that the distribution, together with certain related transactions, should be treated as a taxable transaction if it determines that any of the facts, assumptions, representations, statements or undertakings upon which the opinion of counsel was based are false or have been violated or if it disagrees with the conclusions in the opinion of counsel. The opinion of counsel is not binding on the IRS, and there can be no assurance that the IRS will not assert a contrary position.
If the distribution, together with certain related transactions, fails to qualify as a transaction that is generally tax-free, for U.S. federal income tax purposes, under Sections 355 and 368(a)(1)(D) of the Code, Varian would recognize taxable gain as if it had sold the Varex common stock in a taxable sale for its fair market value, and Varian stockholders who received Varex shares in the distribution would be subject to tax as if they had received a taxable distribution equal to the fair market value of such shares.
Under the Tax Matters Agreement entered into by Varian and Varex in connection with the separation, Varex is generally required to indemnify Varian for any taxes resulting from the separation (and any related costs and other damages) to the extent such amounts resulted from (i) an acquisition of all or a portion of the equity securities or assets of Varex, whether by merger or otherwise (and regardless of whether Varex participated in or otherwise facilitated the acquisition), (ii) other actions or failures to act by Varex or (iii) any of the representations or undertaking of Varex contained in any of the separation-related agreements or in the documents relating to the opinion of counsel being incorrect or violated. Any such indemnity obligations could be material.
Varex may not be able to engage in desirable strategic or capital-raising transactions following the separation.
Under current law, a spin-off can be rendered taxable to the parent corporation and its stockholders as a result of certain post-spin-off acquisitions of shares or assets of the spun-off corporation. For example, a spin-off may result in taxable gain to the parent corporation under Section 355(e) of the Code if the spin-off were later deemed to be part of a plan (or series of related transactions) pursuant to which one or more persons acquire, directly or indirectly, shares representing a 50% or greater interest (by vote or value) in the spun-off corporation. To preserve the tax-free treatment of the separation and the distribution, and in addition to Varex’s indemnity obligation described immediately above, the Tax Matters Agreement restricts Varex, for the two-year period following the separation, except in specific circumstances, from: (i) entering into any transaction pursuant to which all or a portion of the shares of Varex common stock would be acquired, whether by merger or otherwise; (ii) issuing equity securities beyond certain thresholds; (iii) repurchasing shares of Varex common stock other than in certain open-market transactions, and (iv) ceasing to actively conduct certain of its businesses. The Tax Matters Agreement also prohibits Varex from taking or failing to take any other action that would prevent the distribution and certain related transactions from qualifying as a transaction that is generally tax-free for U.S. federal income tax purposes under Sections 355 and 368(a)(1)(D) of the Code. These restrictions may limit Varex’s ability to pursue certain strategic transactions, equity issuances or repurchases or other transactions that it may believe to be in the best interests of its stockholders or that might increase the value of its business.
As a result of the distribution, certain members of management and directors hold stock in both Varian and Varex, and as a result may face actual or potential conflicts of interest.
After the distribution, certain of the management and directors of each of Varian and Varex own both Varian common stock and Varex common stock. This ownership overlap could create, or appear to create, potential conflicts of interest when Varex
management and directors and Varian’s management and directors face decisions that could have different implications for Varex and Varian. For example, potential conflicts of interest could arise in connection with the resolution of any dispute between Varex and Varian regarding the terms of the agreements governing the distribution and Varex’s relationship with Varian thereafter. These agreements include the Separation and Distribution Agreement, the Tax Matters Agreement, the Employee Matters Agreement, the Transition Services Agreement, the Intellectual Property Matters Agreement, the Trademark License Agreement and one or more Supply/Distribution Agreements. Potential conflicts of interest may also arise out of any commercial arrangements that Varex or Varian may enter into in the future.
Varex may not achieve some or all of the expected benefits of the separation, and the separation may materially and adversely affect Varex’s business.
Varex may not be able to achieve the full strategic and financial benefits expected to result from the separation, or such benefits may be delayed or not occur at all. The separation and distribution is expected to provide the following benefits, among others:
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more effective pursuit of each company’s distinct operating priorities and strategies;
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more efficient allocation of capital for both Varian and Varex;
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direct access by Varex to the capital markets;
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facilitation of incentive compensation arrangements for employees more directly tied to the performance of the relevant company’s business, and potential enhancement of employee hiring and retention by, among other things, improving the alignment of management and employee incentives with performance and growth objectives, while at the same time creating an independent equity structure that will facilitate Varex’s ability to effect future acquisitions utilizing Varex common stock; and
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a distinct investment identity, allowing investors to evaluate the merits, performance and future prospects of Varex separately from Varian.
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Varex may not achieve these and other anticipated benefits for a variety of reasons, including, among others: (i) following the separation, Varex may be more susceptible to market fluctuations and other adverse events than if it were still a part of Varian; and, (ii) following the separation, Varex’s business is less diversified and has less scale than Varian’s business prior to the separation. If Varex fails to achieve some or all of the benefits expected to result from the separation, or if such benefits are delayed, the business, operating results and financial condition of Varex could be materially and adversely affected.
Varex or Varian may fail to perform under various transaction agreements that have been executed as part of the separation or Varex may fail to have necessary systems and services in place when certain of the transaction agreements expire.
In connection with the separation, Varex and Varian entered into a Separation and Distribution Agreement, as well as various other agreements, including a Transition Services Agreement, an Intellectual Property Matters Agreement, a Tax Matters Agreement, one or more Supply/Distribution Agreements, a Trademark License Agreement and an Employee Matters Agreement. The Separation and Distribution Agreement, the Tax Matters Agreement, the Employee Matters Agreement and the Intellectual Property Matters Agreement determine the allocation of assets and liabilities between the companies following the separation for those respective areas and include any necessary indemnifications related to liabilities and obligations. The Transition Services Agreement provides for the performance of certain services by each company for the benefit of the other for a limited period of time after the separation and the Supply/Distribution Agreements provide for the provision of products and services by each company and for the benefit of the other. Varex will rely on Varian to satisfy its performance and payment obligations under these agreements. If Varian is unable to satisfy its obligations under these agreements, including its indemnification obligations, Varex could incur operational difficulties or losses. If Varex does not have in place its own systems and services, or if Varex does not have agreements with other providers of these services once certain transaction agreements expire, Varex may not be able to operate its business effectively, and its profitability may decline.
Potential liabilities may arise due to fraudulent transfer considerations, which could materially and adversely affect Varex’s financial condition and its results of operations.
In connection with the separation and distribution, Varian has undertaken several corporate restructuring transactions, which, along with the separation and distribution, may be subject to federal and state fraudulent conveyance and transfer laws. If, under these laws, a court were to determine that, at the time of the separation and distribution, any entity involved in these restructuring transactions or the separation and distribution:
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was rendered insolvent by reason of the separation and distribution;
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had remaining assets constituting unreasonably small capital; or,
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intended to incur, or believed it would incur, debts beyond its ability to pay these debts as they matured,
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then the court could void the separation and distribution, in whole or in part, as a fraudulent conveyance or transfer. The court could then require Varex’s stockholders to return to Varian some or all of the shares of Varex common stock issued in the distribution, or require Varian or Varex, as the case may be, to fund liabilities of the other company for the benefit of creditors. The measure of insolvency will vary depending upon the jurisdiction whose law is being applied. Generally, however, an entity would be considered insolvent if the fair value of its assets was less than the amount of its liabilities or if it incurred debt beyond its ability to repay the debt as it matures.
Fulfilling Varex’s obligations incidental to being a public company, including with respect to the requirements of and related rules under the Sarbanes-Oxley Act of 2002, will place significant demands on Varex’s management, administrative and operational resources, including accounting and information technology resources.
As a public company, Varex is subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), the Sarbanes-Oxley Act and the Dodd-Frank Act and is required to prepare its financial statements according to the rules and regulations required by the SEC. In addition, the Exchange Act requires that Varex file annual, quarterly and current reports. Varex’s failure to prepare and disclose this information in a timely manner or to otherwise comply with applicable law could subject us to penalties under federal securities laws, expose us to lawsuits and restrict Varex’s ability to access financing.
In addition, the Sarbanes-Oxley Act requires that Varex, among other things, establish and maintain effective internal controls and procedures for financial reporting and disclosure purposes. Internal control over financial reporting is complex and may be revised over time to adapt to changes in Varex’s business, or changes in applicable accounting rules. Varex cannot assure that its internal control over financial reporting will be effective in the future or that a material weakness will not be discovered with respect to a prior period for which it had previously believed that internal controls were effective. If Varex is not able to maintain or document effective internal control over financial reporting, its independent registered public accounting firm will not be able to certify as to the effectiveness of Varex’s internal control over financial reporting.
Matters impacting Varex’s internal controls may cause Varex to be unable to report its financial information on a timely basis, or may cause Varex to restate previously-issued financial information, and thereby subject Varex to adverse regulatory consequences, including sanctions or investigations by the SEC or violations of applicable stock exchange listing rules. There could also be a negative reaction in the financial markets due to a loss of investor confidence in Varex and the reliability of its financial statements. In addition, by virtue of its smaller size, Varex will be subject to a lower materiality threshold than Varian. Confidence in the reliability of Varex’s financial statements is also likely to suffer if Varex or its independent registered public accounting firm report a material weakness in Varex’s internal control over financial reporting. This could have a material adverse effect on Varex by, for example, leading to a decline in its share price and impairing its ability to raise additional capital.
For as long as Varex is an emerging growth company under the recently enacted JOBS Act, its independent registered public accounting firm will not be required to attest to the effectiveness of Varex’s internal control over financial reporting pursuant to Section 404(b). An independent assessment of the effectiveness of Varex’s internal controls could detect problems that Varex’s management’s assessment might not. Undetected material weaknesses in Varex’s internal controls could lead to financial statement restatements and require Varex to incur the expense of remediation.
Risks Related to Varex’s Common Stock
Varex cannot be certain that an active trading market for its common stock will develop or be sustained, and Varex’s stock price may decline or fluctuate significantly.
Prior to the distribution, a public market for Varex common stock did not exist. Varex cannot guarantee that an active trading market will develop or be sustained for its common stock. Nor can Varex predict the prices at which shares of its common stock may trade. Similarly, Varex cannot predict the long-term effect of the distribution on the trading prices of its common stock or whether the combined market value of the shares of Varex common stock and the shares of Varian common stock will be less than, equal to or greater than the market value of shares of Varian common stock prior to the distribution.
The market price of Varex common stock may decline or fluctuate significantly due to a number of factors, some of which may be beyond Varex’s control, including:
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actual or anticipated fluctuations in Varex’s operating results;
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changes in earnings estimated by securities analysts or Varex’s ability to meet those estimates;
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the operating and stock price performance of comparable companies;
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changes in Varex’s stockholder base due to the separation;
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changes to the regulatory and legal environment in which Varex operates; and,
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domestic and worldwide economic conditions.
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There may be substantial and rapid changes in Varex’s stockholder base, which may cause Varex’s stock price to fluctuate significantly.
Many investors holding shares of Varian common stock may hold that stock because of a decision to invest in a company with Varian’s profile. Following the distribution, the shares of Varex common stock held by those investors represent an investment in an imaging components company with a different profile. This may not be aligned with a holder’s investment strategy and may cause the holder to sell the shares rapidly. In addition, since Varex is not in the S&P 500 index, Varian investors who have an investment strategy of tracking an index fund, such as the S&P 500 index, will likely sell the shares of Varex common stock that they receive in the distribution. As a result, the price of Varex common stock may decline or experience volatility as Varex’s stockholder base changes.
Varex does not currently expect to pay dividends on its common stock. There is no assurance as to whether or when Varex will pay any dividends on its common stock or as to the amount of any such dividends.
Varex does not currently expect to pay dividends on its common stock. The payment of any dividends in the future, and the timing and amount thereof, to Varex stockholders will fall within the discretion of Varex’s board of directors. The board’s decisions regarding the payment of dividends will depend on many factors, such as Varex’s financial condition, earnings, capital requirements, debt service obligations, restrictive covenants in Varex’s debt, industry practice, legal requirements, regulatory constraints and other factors that the board deems relevant. Varex’s ability to pay dividends will depend on its ongoing ability to generate cash from operations and on its access to the capital markets. Varex cannot guarantee that it will pay a dividend in the future or continue to pay any dividends if Varex commences paying dividends.
Varex is an “emerging growth company,” and, as a result of the reduced disclosure and governance requirements applicable to emerging growth companies, its common stock may be less attractive to investors.
Varex is an “emerging growth company,” as defined in the JOBS Act, and it intends to take advantage of some of the exemptions from the reporting requirements that are afforded to emerging growth companies including, but not limited to, scaled disclosure requirements relating to financial statements and executive compensation, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. Varex cannot predict if investors will find its common stock less attractive because it intends to rely on these exemptions. If some investors find its common stock less attractive as a result, there may be a less active trading market for its common stock and its stock price may become more volatile. Varex may take advantage of these exemptions until it is no longer an emerging growth company.
Your percentage ownership in Varex may be diluted in the future.
In the future, your percentage ownership in Varex may be diluted because of equity awards that Varex will be granting to Varex’s directors, officers and employees or otherwise as a result of equity issuances for acquisitions or capital market transactions. Varex’s employees have awards in respect of shares of its common stock as a result of conversion of their Varian stock awards (in whole or in part) to Varex stock awards. Varex anticipates its executive compensation committee will grant additional stock-based awards to its employees. Such awards will have a dilutive effect on Varex’s earnings per share, which could adversely affect the market price of Varex common stock. From time to time, Varex will issue additional stock-based awards to its employees under Varex’s employee benefits plans.
In addition, Varex’s amended and restated certificate of incorporation authorize Varex to issue, without the approval of Varex’s stockholders, one or more classes or series of preferred stock having such designation, powers, preferences and relative, participating, optional and other special rights, including preferences over Varex’s common stock respecting dividends and distributions, as Varex’s board of directors generally may determine. The terms of one or more classes or series of preferred stock could dilute the voting power or reduce the value of Varex’s common stock. For example, Varex could grant the holders of preferred stock the right to elect some number of Varex’s directors in all events or on the happening of specified events or the right to veto specified transactions. Similarly, the repurchase or redemption rights or liquidation preferences that Varex could assign to holders of preferred stock could affect the residual value of the common stock.
Certain provisions in Varex’s amended and restated certificate of incorporation and bylaws, and of Delaware law, may prevent or delay an acquisition of Varex, which could decrease the trading price of Varex’s common stock.
Varex’s amended and restated certificate of incorporation and amended and restated bylaws contain, and Delaware law contains, provisions that are intended to deter coercive takeover practices and inadequate takeover bids by making such practices or bids unacceptably expensive to the bidder and to encourage prospective acquirers to negotiate with Varex’s board of directors rather than to attempt a hostile takeover. These provisions include, among others:
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the inability of Varex’s stockholders to call a special meeting;
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the inability of Varex’s stockholders to act without a meeting of stockholders;
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rules regarding how stockholders may present proposals or nominate directors for election at stockholder meetings;
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the right of Varex’s board of directors to issue preferred stock without stockholder approval;
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the division of Varex’s board of directors into three classes of directors, with each class serving a staggered three-year term, and this classified board provision could have the effect of making the replacement of incumbent directors more time-consuming and difficult, until the 2022 annual meeting of stockholders, after which directors will be elected annually;
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a provision that stockholders may only remove directors with cause while the board is classified;
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the ability of Varex’s directors, and not stockholders, to fill vacancies on Varex’s board of directors; and,
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the requirement that the affirmative vote of stockholders holding at least 66 2/3% of Varex’s voting stock is required to amend certain provisions in Varex’s amended and restated certificate of incorporation (relating to the term and removal of its directors, the filling of its board vacancies, the calling of special meetings of stockholders, stockholder action by written consent, the elimination of liability of directors to the extent permitted by Delaware law and indemnification of directors and officers); provided, however, that the provisions of the amended and restated certificate of incorporation relating to the 66 2/3% voting threshold will be of no force and effect effective as of the completion of the 2021 annual meeting of stockholders, and the amended and restated certificate of incorporation may thereafter be amended by the affirmative vote of the holders of at least a majority of the outstanding voting stock.
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In addition, because Varex did not elect to be exempt from Section 203 of the Delaware General Corporation Law (the “DGCL”), this provision could also delay or prevent a change of control that stockholders may favor. Section 203 provides that, subject to limited exceptions, persons that acquire, or are affiliated with a person that acquires, more than 15% of the outstanding voting stock of a Delaware corporation (an “interested stockholder”) shall not engage in any business combination with that corporation, including by merger, consolidation or acquisitions of additional shares, for a three-year period following the date on which the person became an interested stockholder, unless (i) prior to such time, the board of directors of such corporation approved either the business combination or the transaction that resulted in the stockholder becoming an interested stockholder; (ii) upon consummation of the transaction that resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of such corporation at the time the transaction commenced (excluding for purposes of determining the voting stock outstanding (but not the outstanding voting stock owned by the interested stockholder) the voting stock owned by directors who are also officers or held in employee benefit plans in which the employees do not have a confidential right to tender or vote stock held by the plan); or, (iii) on or subsequent to such time the business combination is approved by the board of directors of such corporation and authorized at a meeting of stockholders by the affirmative vote of at least two-thirds of the outstanding voting stock of such corporation not owned by the interested stockholder.
Varex believes these provisions will protect its stockholders from coercive or otherwise unfair takeover tactics by requiring potential acquirers to negotiate with Varex’s board of directors and by providing Varex’s board of directors with more time to assess any acquisition proposal. These provisions are not intended to make Varex immune from takeovers. However, these provisions will apply even if the offer may be considered beneficial by some stockholders and could delay or prevent an acquisition that Varex’s board of directors determines is not in the best interests of Varex and Varex’s stockholders. These provisions may also prevent or discourage attempts to remove and replace incumbent directors.
In addition, an acquisition or further issuance of Varex’s stock could trigger the application of Section 355(e) of the Code, causing the distribution to be taxable to Varian. Under the Tax Matters Agreement, Varex would be required to indemnify Varian for the resulting tax, and this indemnity obligation might discourage, delay or prevent a change of control that you may consider favorable.
Varex’s amended and restated certificate of incorporation contains an exclusive forum provision that may discourage lawsuits against Varex and Varex’s directors and officers.
Varex’s amended and restated certificate of incorporation provides that unless the board of directors otherwise determines, the state courts in the State of Delaware or, if no state court located within the State of Delaware has jurisdiction, the federal court for the District of Delaware, will be the sole and exclusive forum for any derivative action or proceeding brought on behalf of Varex, any action asserting a claim of breach of a fiduciary duty owed by any director or officer of Varex to Varex or Varex’s stockholders, any
action asserting a claim against Varex or any director or officer of Varex arising pursuant to any provision of the DGCL or Varex’s amended and restated certificate of incorporation or bylaws, or any action asserting a claim against Varex or any director or officer of Varex governed by the internal affairs doctrine. This exclusive forum provision may limit the ability of Varex’s stockholders to bring a claim in a judicial forum that such stockholders find favorable for disputes with Varex or Varex’s directors or officers, which may discourage such lawsuits against Varex and Varex’s directors and officers. Alternatively, if a court outside of Delaware were to find this exclusive forum provision inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings described above, Varex may incur additional costs associated with resolving such matters in other jurisdictions, which could materially and adversely affect Varex’s business, financial condition or results of operations.