# Varex Imaging Corp (VREX) FY 2021 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Varex Imaging Corp's 10-K for fiscal year 2021.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1681622/000168162221000103/vrex-20211001.htm
Accession: 0001681622-21-000103
Filing date: 2021-11-19
Report date: 2021-10-01
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/VREX/
All MD&A years: /company/VREX/mda/
Next year: /company/VREX/mda/fy2022/ (FY 2022)

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

    The following discussion and analysis contains forward-looking statements relating to future events or our future financial or operating performance that involve risks and uncertainties, as set forth above under "Forward-Looking Statements." Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors described in this Annual Report on Form 10-K.

Our Business

    Varex Imaging Corporation is a leading innovator, designer and manufacturer of X-ray tubes, digital detectors, linear accelerators and other image software processing solutions, which are critical components of a variety of X-ray based imaging equipment. Our success depends, among other things, on our ability to anticipate and respond to changes in our markets, the direction of technological innovation and the demands of our customers. For additional information on our business, see Part I, Item 1.

Impact of COVID-19 and the General Economic Environment

    The unprecedented nature of the COVID-19 pandemic and its effect on the global economy began to significantly disrupt our business in fiscal year 2020 by initially reducing demand for our products followed by strong recovery in demand but increasing variability in supply of raw materials and manufacturing productivity.

    During the twelve months ended October 1, 2021, demand for many of our products recovered to pre-pandemic levels and our business has continued to grow. We believe that demand for our products has increased due to increased investments in healthcare and diagnostics coupled with end-users (such as hospitals) making capital purchases that were previously deferred due to the uncertainty surrounding COVID-19. While we are encouraged by the recovery that we have seen, we remain cautious as many factors remain unpredictable.

    We continue to experience logistic, supply chain, and manufacturing challenges that we expect will continue into 2022. As economies around the world continue to recover, shortages in raw materials have become more widespread. During the latter half of fiscal year 2021, we have experienced shortages of certain materials and have used more of our inventory on hand than we have used historically. Shortages of materials, particularly micro-controller chips and associated electronic components, have caused and may continue to cause, delays in manufacturing products for our customers. In some cases, raw material shortages and delivery delays from our suppliers are communicated to us with very little advanced warning, which has caused operational and customer order fulfillment challenges. While we are dedicating significant resources to manage, mitigate, and resolve these issues, we currently expect supply chain challenges to continue to impact our ability to deliver products to our customers over the next several quarters. Increased freight charges and shipping delays have also become more common over the last few months and are expected to continue into the foreseeable future. Due to the rising cost environment, in addition to ongoing expense management, we have begun to raise prices on certain products. We anticipate to make pricing adjustments throughout fiscal year 2022.

    During the twelve months ended October 1, 2021, our manufacturing facilities continued to operate with minimal disruption. In accordance with government guidelines, we have modified certain COVID-19 related protocols, including social distancing and mask requirements. In the event COVID-19 cases continue an upward trajectory, we may be required to re-implement certain COVID-19 related precautions.

    The full extent to which the COVID-19 pandemic and ensuing supply chain challenges have and will directly or indirectly impact us, including our business, financial condition, and results of operations, will depend on future developments that are highly uncertain and cannot be accurately predicted. We will continue to actively monitor the situation and may take further actions that alter our business operations or that we determine are in the best interests of our employees, customers, suppliers, and stockholders. For additional information on risks related to the pandemic and other supply chain risks that could impact our results, see Part I, Item 1A - Risk Factors.

Fiscal Year

    Our fiscal year is the 52- or 53-week period ending on the Friday nearest September 30. Fiscal year 2021 was the 52-week period that ended October 1, 2021, fiscal year 2020 was the 53-week period that ended October 2, 2020, and fiscal year 2019 was the 52-week period that ended September 27, 2019. Set forth below is a discussion of our results of operations for fiscal years 2021, 2020 and 2019.

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Results of Operations

    Our annual report on Form 10-K for the fiscal year ended October 2, 2020, filed November 30, 2020, includes a discussion and analysis of our year-over-year changes, financial condition, and results of operations for the fiscal years ended October 2, 2020 and September 27, 2019 in Item 7 of Part II therein.

Comparison of Results of Operations for Fiscal Year 2021 and 2020

Revenues, net

[[GREPCENT_TABLE]]
[["(In millions)","2021","","% Change","","2020","","% Change","","2019"],["Medical","$","643.8","","","10%","","$","584.5","","","(2)%","","$","596.8"],["Industrial","174.3","","","13%","","153.8","","","(16)%","","183.8"],["Total revenues, net","$","818.1","","","11%","","$","738.3","","","(5)%","","$","780.6"],["Medical as a percentage of total revenues","79","%","","","","79","%","","","","76","%"],["Industrial as a percentage of total revenues","21","%","","","","21","%","","","","24","%"]]
[[/GREPCENT_TABLE]]

    Medical revenues increased $59.3 million primarily due to increased sales of X-ray tubes and digital detectors for oncology, dental, mammography and radiographic applications.

    Industrial revenues increased $20.5 million due to increased sales of X-ray tubes for airport security and digital detectors for

inspection applications.

Revenues by Region

[[GREPCENT_TABLE]]
[["(In millions)","2021","","% Change","","2020","","% Change","","2019"],["Americas","$","268.5","","","5%","","$","255.0","","","(10)%","","$","282.6"],["EMEA","276.3","","","19%","","231.5","","","(14)%","","269.0"],["APAC","273.3","","","9%","","251.8","","","10%","","229.0"],["Total revenues, net","$","818.1","","","11%","","$","738.3","","","(5)%","","$","780.6"],["Americas as a percentage of total revenues","33","%","","","","35","%","","","","36","%"],["EMEA as a percentage of total revenues","34","%","","","","31","%","","","","34","%"],["APAC as a percentage of total revenues","33","%","","","","34","%","","","","29","%"]]
[[/GREPCENT_TABLE]]

    The Americas revenues increased $13.5 million primarily due to increased sales of X-ray tubes, digital detectors and computer-aided detection software. EMEA revenues increased $44.8 million primarily due to increased sales of digital detectors, high voltage cables, and X-ray tubes. APAC revenues increased $21.5 million primarily due to increased sales of OEM X-ray tubes in China.

Gross Profit

[[GREPCENT_TABLE]]
[["(In millions)","2021","","% Change","","2020","","% Change","","2019"],["Medical","$","203.2","","","49%","","$","136.4","","","(28)%","","$","188.9"],["Industrial","68.3","","","27%","","53.8","","","(21)%","","67.8"],["Total gross profit","$","271.5","","","43%","","$","190.2","","","(26)%","","$","256.7"],["Medical gross margin","32","%","","","","23","%","","","","32","%"],["Industrial gross margin","39","%","","","","35","%","","","","37","%"],["Total gross margin","33","%","","","","26","%","","","","33","%"]]
[[/GREPCENT_TABLE]]

    Gross margin increased for fiscal year 2021 compared to 2020. The gross profit for fiscal year 2020 included $22.2 million of restructuring and product discontinuation charges and purchase price accounting adjustments. The medical segment gross margin in 2021 increased primarily due to increased volumes of X-ray tubes and medical detectors, cost reduction actions undertaken in fiscal year 2020, which have resulted in cost savings in fiscal year 2021, and favorable product mix. The industrial segment gross margin in

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2021 increased primarily due to higher volumes of X-ray tubes for security applications and non-destructive testing, favorable product mix, and cost reduction actions undertaken in fiscal year 2020, which have resulted in cost savings in fiscal year 2021.

Operating Expenses

[[GREPCENT_TABLE]]
[["(In millions)","2021","","% Change","","2020","","% Change","","2019"],["Research and development","$","71.9","","","(9)%","","$","78.9","","","1%","","$","78.1"],["As a percentage of total revenues","8.8","%","","","","10.7","%","","","","10.0","%"],["Selling, general and administrative","$","125.5","","","(12)%","","$","142.2","","","11%","","$","128.1"],["As a percentage of total revenues","15.3","%","","","","19.3","%","","","","16.4","%"],["Impairment of intangible assets","$","\u2014","","","(100)%","","$","2.8","","","(42)%","","$","4.8"],["As a percentage of total revenues","\u2014","%","","","","0.4","%","","","","0.6","%"],["Operating expenses","$","197.4","","","(12)%","","$","223.9","","","6%","","$","211.0"],["As a percentage of total revenues","24.1","%","","","","30.3","%","","","","27.0","%"]]
[[/GREPCENT_TABLE]]

Research and Development

    Research and development costs for fiscal year 2021 decreased to 8.8% of revenues due to lower engineering related material purchases and cost reduction actions undertaken in fiscal year 2020, which have resulted in cost savings in fiscal year 2021, as well as higher revenues in fiscal year 2021. We are committed to investing in research and development efforts to support long-term growth objectives by bringing new and innovative products to market for our customers.

Selling, General and Administrative

    Selling, general and administrative expenses as a percentage of total revenues decreased to 15.3% for fiscal year 2021 from 19.3% for fiscal year 2020 due to lower audit and consulting fees associated with the remediation of internal control deficiencies, cost reduction actions undertaken in fiscal year 2020, which have resulted in cost savings in fiscal year 2021.

Impairment of intangible assets

    Impairment of intangible assets decreased for fiscal year 2021 to $0.0 million as compared to $2.8 million for fiscal year 2020. See Note 12. Goodwill and Intangible Assets, included in the accompanying notes to our consolidated financial statements for further information.

Interest and Other Expense, Net

    The following table summarizes our interest and other expense, net:

[[GREPCENT_TABLE]]
[["(In millions)","2021","","% Change","","2020","","% Change","","2019"],["Interest income","$","0.1","","","\u2014%","","$","0.1","","","\u2014%","","$","0.1"],["Interest expense","(42.1)","","","34%","","(31.4)","","","49%","","(21.1)"],["Other expense, net","(3.5)","","","(54)%","","(7.6)","","","138%","","(3.2)"],["Interest and other expenses, net","$","(45.5)","","","17%","","$","(38.9)","","","61%","","$","(24.2)"]]
[[/GREPCENT_TABLE]]

    Interest and other expense, net increased in fiscal year 2021 compared to fiscal year 2020. Interest expense increased primarily due to the interest related to our Convertible Notes issued during June 2020, and the issuance of our Senior Secured Notes in September 2020 which had higher effective interest rates, as well as the partial extinguishment of the Senior Secured Notes. Other expense, net decreased in fiscal year 2021 compared to fiscal year 2020. Other expense, net during fiscal year 2020 consisted primarily of the impairment of certain investments in privately-held companies and a decrease in the fair value of the deferred consideration related to the Direct Conversion acquisition, which did not recur during fiscal year 2021.

Taxes on Income

[[GREPCENT_TABLE]]
[["","Fiscal Years"],["","2021","","2020"],["Effective tax rate","37.4","%","","20.9","%"]]
[[/GREPCENT_TABLE]]

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    We had an income tax expense of $10.7 million and an income tax benefit of $15.2 million, for effective rates of 37.4% and 20.9%, for fiscal years 2021 and 2020, respectively.

    During fiscal year 2021, our effective tax rate varied from the U.S. federal statutory rate of 21% primarily due to the unfavorable impact of U.S. deferred tax attributes and losses in certain foreign jurisdictions for which no benefit is recognized and a reduction in benefit for U.S. net operating losses carried back to prior years. These unfavorable items are partially offset by the favorable impact of R&D tax credits and U.S. tax reform international provisions.

    During fiscal year 2020, our effective tax rate varied from the U.S. federal statutory rate of 21% primarily because of the favorable impact of U.S. net operating losses to be carried back to tax years with greater U.S. federal statutory rates. These favorable tax items are mostly offset by the unfavorable impact of additional losses in certain foreign jurisdictions, limitations on interest expense, and R&D credits for which no benefit is recognized.

    We estimated the fiscal year 2021 GILTI (global intangible low-taxed income), BEAT (base-erosion anti-abuse tax), FDII (foreign-derived intangible income), limitations on interest expense deductions, and other components of U.S. Tax Reform, and have included these amounts in the calculation of the fiscal year 2021 tax provision. We made an accounting policy election, as allowed by the SEC and FASB, to recognize the impact of GILTI as a period cost if and when incurred.

Liquidity and Capital Resources

    We assess our liquidity in terms of our ability to generate cash to fund our operations, including working capital and investing activities. We continue to generate cash from operating activities and believe that our operating cash flow, cash on our balance sheet and availability under our ABL Facility will be sufficient to allow us to continue to invest in our existing businesses, to manage our capital structure on a short and long-term basis, and to meet our anticipated operating cash needs. The maximum availability under our ABL Facility was $100.0 million as of October 1, 2021; however, the borrowing base under the ABL Facility fluctuates from month-to-month depending on the amount of eligible accounts receivable and inventory. See Item 1A. “Risk Factors” for a further discussion. At October 1, 2021 we had $431.7 million in long-term debt, net of discounts and deferred issuance costs of $46.1 million.

    On July 15, 2021, the Company redeemed $30 million of principal of our $300 million, 7.875% Senior Secured Notes due 2027 (the "Senior Secured Notes"), in accordance with the terms and conditions of the governing indenture by paying cash of $31.5 million, inclusive of the redemption premium and accrued interest, and recognized a $1.4 million loss related to the redemption premium and the write-off of previously recorded debt issuance costs. See Note 10. Borrowings, in the accompanying notes to our consolidated financial statements for more information regarding our indebtedness.

    Our consolidated cash and cash equivalents increased from $100.6 million as of October 2, 2020, to $144.6 as of October 1, 2021. This increase was primarily due to cash inflows from operating activities of $92.6 million, offset by capital expenditures of $15.1 million and debt repayments of $33.1 million.

Cash and Cash Equivalents

    The following table summarizes our cash and cash equivalents:

[[GREPCENT_TABLE]]
[["(In millions)","October 1, 2021","","October 2, 2020","","$ Change","","% Change"],["Cash and cash equivalents","$","144.6","","","$","100.6","","","$","44.0","","","43.7","%"]]
[[/GREPCENT_TABLE]]

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Borrowings

    The following table summarizes the changes in our debt outstanding:

[[GREPCENT_TABLE]]
[["(In millions, except for percentages)","October 1, 2021","","October 2, 2020","","$ Change","","% Change"],["Current maturities of long-term debt"],["Current portion of other debt","$","2.8","","","$","2.5","","","$","0.3","","","$","0.1"],["Total current maturities of long-term debt:","$","2.8","","","$","2.5","","","$","0.3","","","12.0","%"],["Non-current maturities of long-term debt:"],["Convertible Senior Unsecured Notes","$","200.0","","","$","200.0","","","$","\u2014","","","\u2014","%"],["Senior Secured Notes","270.0","","","300.0","","","(30.0)","","","(10.0)","%"],["Other debt","7.8","","","8.8","","","(1.0)","","","(11.4)","%"],["Total non-current maturities of long-term debt:","$","477.8","","","$","508.8","","","$","(31.0)","","","(6.1)","%"],["Unamortized issuance costs and debt discounts"],["Unamortized discount - Convertible Notes","$","(37.6)","","","$","(45.4)","","","$","7.8","","","(17.2)","%"],["Unamortized issuance costs - Convertible Notes","(4.1)","","","(5.0)","","","0.9","","","(18.0)","%"],["Debt issuance costs - Senior Secured Notes","(4.4)","","","(5.6)","","","1.2","","","(21.4)","%"],["Total","$","(46.1)","","","$","(56.0)","","","$","9.9","","","(17.7)","%"],["Total debt outstanding, net","$","434.5","","","$","455.3","","","$","(20.8)","","","(4.6)","%"]]
[[/GREPCENT_TABLE]]

Cash Flows

[[GREPCENT_TABLE]]
[["","Fiscal Years"],["(In millions)","2021","","2020","","2019"],["Net cash flow provided by (used in):"],["Operating activities","$","92.6","","","$","13.2","","","$","71.9"],["Investing activities","(16.2)","","","(26.9)","","","(93.2)"],["Financing activities","(32.3)","","","83.6","","","(0.1)"],["Effects of exchange rate changes on cash and cash equivalents","(0.1)","","","0.9","","","(0.7)"],["Net increase (decrease) in cash and cash equivalents","$","44.0","","","$","70.8","","","$","(22.1)"]]
[[/GREPCENT_TABLE]]

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

    For fiscal year 2021, compared to fiscal year 2020, net cash provided by operating activities were as follows:

•Net income of $17.9 million compared to net loss of $57.4 million,

•Non-cash adjustments to net income were $66.5 million compared to $84.5 million,

•Operating assets and liabilities activity:

◦Accounts receivable increased by $32.9 million compared to a decrease of $17.7 million,

◦Inventories decreased by $42.8 million compared to an increase of $42.7 million,

◦Prepaid expenses and other assets increased by $0.9 million compared to $9.3 million,

◦Accounts payable increased by $13.6 million compared to a decrease of $14.3 million,

◦Accrued liabilities and other long-term operating liabilities decreased by $12.2 million compared to a decrease of $8.1 million, and

◦Deferred revenues decreased by $0.6 million compared to an increase of $2.0 million.

    Net cash used in investing activities. Cash used in investing activities was $16.2 million and $26.9 million for the fiscal years 2021 and 2020, respectively. The decrease in cash used in investing activities was primarily due to higher capital spending during the twelve months ended October 2, 2020, related primarily to the building of our facility in the Netherlands.

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    Net Cash Provided by (Used in) Financing Activities. We used $32.3 million of cash in financing activities for the twelve months ended October 1, 2021. Net cash used in financing activity for the twelve months ended October 1, 2021, was primarily due to our early redemption of $30 million of our Senior Secured Notes. Net cash provided by financing activity for the twelve months ended October 2, 2020, was primarily due to our issuance of $200.0 million in aggregate principal amount of 4.00% unsecured convertible senior notes due 2025 (“Convertible Notes”). The net proceeds from the issuance of the Convertible Notes, after deducting transaction fees, were approximately $193.1 million. In connection with the offering of the Convertible Notes, we separately entered into privately negotiated convertible note hedge transactions (collectively, the “Hedge Transactions”). The Hedge Transactions cover, subject to customary anti-dilution adjustments, the number of shares of our common stock that initially underlay the Convertible Notes. We also entered into warrant transactions (collectively, the “Warrant Transactions” and, together with the Hedge Transactions, the “Call Spread Transactions”), whereby we sold warrants at a higher strike price relating to the same number of shares of our common stock that initially underlay the Convertible Notes, subject to customary anti-dilution adjustments. We used $11.2 million of the net proceeds from the issuance of the Convertible Notes to pay the cost of the Call Spread Transactions. Additionally, during the twelve months ended October 2, 2020, we had borrowings under our credit agreement of $91.7 million and repayments of borrowings of $218.0 million.

    Additionally, during fiscal year 2020 we issued $300.0 million aggregate principal amount of Senior Secured Notes. The net proceeds from the Senior Secured Notes after initial purchasers’ discount, commissions and estimated fees and expenses of $5.6 million, were approximately $294.4 million. We used $267.5 million of the proceeds from the offering to terminate and repay our previously existing credit agreement.

Days Sales Outstanding

    Trade accounts receivable days sales outstanding (“DSO”) was 62 days and 66 days at October 1, 2021 and October 2, 2020, respectively. Our accounts receivable and DSO are impacted by a number of factors, primarily including the timing of product shipments, collections performance, payment terms, the mix of revenues from different regions and the effects of economic instability.

Contractual Obligations

    The following table summarizes, as of October 1, 2021, the total amount of future payments due in various future periods:

[[GREPCENT_TABLE]]
[["","Payments Due by Period"],["(In millions)","Total","","Fiscal Year 2022","","Fiscal Years 2023-2024","","Fiscal Years 2025-2026","","Beyond"],["Lease obligations","$","29.9","","","$","7.6","","","$","9.3","","","$","6.3","","","$","6.7"],["Principal payments on borrowings","480.6","","","2.8","","","4.3","","","203.1","","","270.4"],["dpiX fixed cost commitment","2.9","","","2.9","","","\u2014","","","\u2014","","","\u2014"],["Dividends to MeVis noncontrolling interest","3.8","","","0.5","","","1.1","","","1.1","","","1.1"],["Supplier equipment acquisition","9.8","","","9.8","","","\u2014","","","\u2014","","","\u2014"],["Total","$","527.0","","","$","23.6","","","$","14.7","","","$","210.5","","","$","278.2"]]
[[/GREPCENT_TABLE]]

    We lease office space under non-cancelable operating leases. For further information on our operating leases, see Note 3. Leases, included in the accompanying notes to our consolidated financial statements.

    For further discussion regarding our borrowings, see Note 10. Borrowings, included in the accompanying notes to our consolidated financial statements.

    In October 2013, we entered into an amended agreement with dpiX and other parties that, among other things, provides us with the right to 50% of dpiX’s total manufacturing capacity produced after January 1, 2014. The amended agreement requires us to pay for 50% of the fixed costs (as defined in the amended agreement), as determined at the beginning of each calendar year. For the remainder of calendar year 2021, we estimate that we have fixed cost commitments of $2.9 million related to this amended agreement. The fixed cost commitment for future periods will be determined and approved by the dpiX board of directors at the beginning of each calendar year. The amended agreement will continue unless the ownership structure of dpiX changes (as defined in the amended agreement).

    In October 2015, pursuant to a Domination and Profit and Loss Transfer Agreement (the “MeVis Agreement”), we committed to grant the noncontrolling shareholders of MeVis: (1) an annual recurring net compensation of €0.95 per MeVis share; and, (2) a put right for their MeVis shares at €19.77 per MeVis share. The annual net payment will continue for the life of the MeVis

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Agreement, which we anticipate will continue for as long as we remain as the controlling shareholder of MeVis. As of October 1, 2021, noncontrolling shareholders together held approximately 0.5 million shares of MeVis, representing 26.3% of the outstanding shares.

    Varex entered into a purchase agreement with a supplier to acquire certain equipment and intellectual property from the supplier that is utilized to manufacture X-ray cables utilized in Varex's products. For more information about our supplier equipment acquisition, see Note 13. Commitments and Contingencies, included in the accompanying notes to our consolidated financial statements.

Contingencies

    From time to time, the Company is a party to or otherwise involved in legal proceedings, claims and government inspections or investigations, customs and duty audits, other contingency matters, both inside and outside the United States, arising in the ordinary course of its business or otherwise. The Company accrues amounts for probable losses, to the extent they can be reasonably estimated, that it believes are adequate to address any liabilities related to legal proceedings and other loss contingencies that the Company believes will result in a probable loss (including, among other things, probable settlement value). A loss or a range of loss is disclosed when it is reasonably possible that a material loss will be incurred and can be estimated or when it is reasonably possible that the amount of a loss, when material, will exceed the recorded provision. The Company did not have any material contingent liabilities as of October 1, 2021 and October 2, 2020. Legal expenses are expensed as incurred.

    See Part 1, Item 3 of this Annual Report for additional information regarding legal proceedings and Note 13. Commitments and Contingencies, in the notes to our consolidated financial statements for further information regarding certain of our contractual obligations and contingencies, which discussion is incorporated herein by reference.

Off-Balance Sheet Arrangements

    In conjunction with the sale of our products in the ordinary course of business, and consistent with industry practice, we provide standard indemnification of business partners and customers for losses suffered or incurred for property damages, death and injury and for patent, copyright or any other intellectual property infringement claims by any third parties with respect to our products. The terms of these indemnification arrangements are generally perpetual. Except for losses related to property damages, the maximum potential amount of future payments we could be required to make under these arrangements is unlimited. As of October 1, 2021, we have not incurred any material costs to defend lawsuits or settle claims related to these indemnification arrangements. As a result, we believe the estimated fair value of these arrangements is minimal.

    We also have indemnification obligations to our directors and officers and certain of our employees that serve as officers or directors of our foreign subsidiaries that may require us to indemnify our directors and officers and those certain employees against liabilities that may arise by reason of their status or service as directors or officers, and to advance their expenses incurred as a result of any legal proceeding against them as to which they could be indemnified.

Critical Accounting Policies and Estimates

    The preparation of our consolidated financial statements and related disclosures in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates and assumptions are based on historical experience and on various other factors that we believe are reasonable under the circumstances. Our critical accounting policies that are affected by accounting estimates require us to use judgments, often as a result of the need to make estimates and assumptions regarding matters that are inherently uncertain, and actual results could differ materially from these estimates.

    We periodically review our accounting policies, estimates and assumptions and make adjustments when facts and circumstances dictate. Such accounting policies require us to use judgments, often as a result of the need to make estimates and assumptions regarding matters that are inherently uncertain, and actual results could differ materially from these estimates. Our critical accounting policies that are affected by accounting estimates include valuation of inventories, assessment of recoverability of goodwill and intangible assets, and income taxes. Such accounting policies require us to use judgments, often as a result of the need to make estimates and assumptions regarding matters that are inherently uncertain, and actual results could differ materially from these estimates. For a discussion of how these estimates and other factors may affect our business, see Item 1A. “Risk Factors.”

Inventories

    Inventories are valued at the lower of cost or net realizable value. Costs include materials, labor and manufacturing overhead and is computed using standard cost (which approximates actual cost) on a first-in-first-out basis. We evaluate the carrying value of

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our inventories taking into consideration such factors as historical and anticipated future sales compared to quantities on hand and the prices we expect to obtain for products in our various markets. We adjust excess and obsolete inventories to net realizable value and write-downs of excess and obsolete inventories are recorded as a component of cost of revenues.

Goodwill and Intangible Assets

    Goodwill is initially recorded when the purchase price paid for a business acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. Our future operating performance will be impacted by the future amortization of these acquired intangible assets and potential impairment charges related to these intangibles or to goodwill if indicators of impairment exist. The allocation of the purchase price from business acquisitions to goodwill and intangible assets could have a material impact on our future operating results. In addition, the allocation of the purchase price of the acquired businesses to goodwill and intangible assets requires us to make significant estimates and assumptions, including estimates of future cash flows expected to be generated by the acquired assets and the appropriate discount rate for those cash flows. Should conditions differ from management’s estimates at the time of the acquisition, material write-downs of intangible assets and/or goodwill may be required, which would adversely affect our operating results.

    We evaluate goodwill for impairment at least annually or whenever an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The evaluation includes consideration of qualitative factors including industry and market considerations, overall financial performance, and other relevant events and factors affecting the reporting unit. If we determine that a quantitative analysis is necessary, we perform a quantitative analysis which consists of a comparison of the fair value of a reporting unit against its carrying amount, including the goodwill allocated to each reporting unit. We determine the fair value of our reporting units based on a combination of income and market approaches. The income approach is based on the present value of estimated future cash flows of the reporting units and the market approach is based on a market multiple calculated for each reporting unit based on market data of other companies engaged in similar business. If the carrying amount of the reporting unit is in excess of its fair value, the difference between the fair value and carrying amount is recorded as an impairment loss. The impairment test for intangible assets with indefinite useful lives, if any, consists of a comparison of fair value to carrying value, with any excess of carrying value over fair value being recorded as an impairment loss.

    In fiscal years 2021, 2020 and 2019, we performed the annual goodwill impairment test for our two reporting units and found no impairment. We performed the annual goodwill analysis as of the first day of the fourth quarter of each fiscal year (using balances as of the end of the third quarter of that fiscal year). For both reporting units, based upon the annual goodwill analysis that we performed as of the first day of the fourth quarter of the respective fiscal years, either a quantitative analysis of the impairment test was not completed based on evaluation of qualitative factors or, if quantitative analysis was completed, the fair value was substantially in excess of carrying value. However, significant changes in our projections of our operating results or other factors could cause us to make interim assessments of impairments in any quarter that could result in some or all of the goodwill being impaired.

    Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions, estimates, and market factors. Estimating the fair value of individual reporting units requires us to make assumptions and estimates regarding our future plans, as well as industry, economic, and regulatory conditions. These assumptions and estimates include estimated future annual net cash flows, income tax rates, discount rates, revenue growth rates, forecasted gross margins, market multiples, terminal value and other market factors. This fair value measurement was based on significant inputs not observable in the market and thus represents a Level 3 fair value measurement. If current expectations of future revenue growth rates and forecasted gross margins, both in size and timing, are not met, if market factors outside of our control, such as discount rates, change, if market multiples decline, or if management’s expectations or plans otherwise change, including as a result of the development of our global five-year operating plan, then one or more of our reporting units might become impaired in the future. The Company will continue to monitor the financial performance of and assumptions for its reporting units. A future impairment charge for goodwill could have a material effect on the Company's consolidated financial position and results of operations.

    We will continue to make assessments of impairment on an annual basis or more frequently if indicators of potential impairment arise.

Taxes on Income

    Current income tax expense or benefit is the amount of income taxes expected to be payable or receivable for the current year. Deferred income tax liabilities or assets are established for the expected future tax consequences resulting from the differences in financial reporting and tax bases of assets and liabilities. Future changes in tax regulation can have a material impact, including tax rate changes or the realization of deferred tax assets. A valuation allowance is provided if it is more likely than not that some or all of the deferred tax assets will not be realized. U.S. Tax Reform introduced a limitation of business interest deduction under IRC Section 163(j), which may be difficult to utilize without significant taxable income. Also, net operating loss carryforwards in jurisdictions with

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current losses provide uncertainty for realization. In addition, we provide reserves for uncertain tax positions when such tax positions do not meet the recognition thresholds or measurement standards prescribed by the authoritative guidance for accounting for income taxes. A portion of the U.S. general business tax credits for research outside of the financial statement line for research and development (R&D) have a small degree of uncertainty. A reasonable reserve is maintained on the uncertain portion until either the Internal Revenue Service chooses to audit, or the statute of limitation expires. A reserve for R&D is typical for companies who calculate and utilize this general business credit. Amounts for uncertain tax positions are adjusted in periods when new information becomes available or when positions are effectively settled. Interest and penalties related to uncertain tax positions are recognized as a component of income tax expense.

    On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was enacted in response to the COVID-19 pandemic. The CARES Act, among other things, permits net operating loss ("NOL") carryovers and carrybacks to offset 100% of taxable income for taxable years beginning before 2021. In addition, the CARES Act allows NOLs incurred in 2018, 2019, and 2020 to be carried back to each of the five preceding taxable years to generate a refund of previously paid income taxes. On July 2, 2020, the US Treasury Department issued a regulation providing an election to waive NOL carryback to a former consolidated group. During fiscal year 2021, we filed NOL carryback claims for U.S. losses incurred in fiscal year 2020 and anticipates cash tax refunds on those claims.

Recent Accounting Standards or Updates Not Yet Effective

    See Note 1. Summary of Significant Accounting Policies, of the notes to the consolidated financial statements for a description of recent accounting standards, including the expected dates of adoption and the estimated effects on our consolidated financial statements.

Backlog

    Backlog is the accumulation of all orders for which revenues have not been recognized and are still considered valid. Backlog also includes a small portion of billed service contracts that are included in deferred revenue. Our estimated total backlog at October 1, 2021 was approximately $327 million.

    Orders may be revised or canceled, either according to their terms or as customers' needs change. Consequently, it is difficult to predict with certainty the amount of backlog that will result in revenues. We perform a quarterly review to verify that outstanding orders in the backlog remain valid. Aged orders that are not expected to be converted to revenues are deemed dormant and are reflected as a reduction in the backlog amounts in the period identified.

    In addition to orders for which revenues have not been recognized and are still considered valid, we have pricing agreements with many of our established customers that span multi-year periods. These pricing agreements include volume ranges under which orders are placed.