# Varex Imaging Corp (VREX) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Varex Imaging Corp's 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1681622/000168162222000091/vrex-20220930.htm
Accession: 0001681622-22-000091
Filing date: 2022-11-18
Report date: 2022-09-30
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/
Previous year: /company/VREX/mda/fy2021/ (FY 2021)
Next year: /company/VREX/mda/fy2023/ (FY 2023)

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, Inflation 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 September 30, 2022, 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 and recent high rates of inflation have increased our costs and could negatively affect our future profit margins. The existence of inflation in the economy has resulted in, and may continue to result in, higher interest rates and capital costs, increased shipping costs, supply shortages, increased costs of labor, weakening exchange rates and other similar effects.

    We continue to experience logistics, supply chain, and manufacturing challenges that we expect will continue into 2023. As economies around the world continue to recover, shortages in raw materials have become more widespread. During the latter half of fiscal year 2021 and throughout fiscal year 2022, we experienced shortages of certain materials and 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 and are expected to continue into the foreseeable future. Due to the rising cost environment, in addition to ongoing expense management, we began to raise prices on certain products in fiscal year 2022 and anticipate making further pricing adjustments throughout fiscal year 2023.

    During the twelve months ended September 30, 2022, our manufacturing facilities continued to operate with minimal disruption. Notwithstanding the foregoing, local government lockdowns, particularly in China, have impacted, and could continue to impact, our manufacturing operations in affected countries.

    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 2022 was the 52-week period that ended September 30, 2022, fiscal year 2021 was the 52-week period that ended October 1, 2021, and fiscal year 2020 was the 53-week period that ended October 2, 2020. Set forth below is a discussion of our results of operations for fiscal years 2022, 2021 and 2020.

Results of Operations

    Our annual report on Form 10-K for the fiscal year ended October 1, 2021, filed November 19, 2021, includes a discussion and analysis of our year-over-year changes, financial condition, and results of operations for the fiscal years ended October 1, 2021

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and October 2, 2020 in Item 7 of Part II therein. Our year-over-year changes, financial condition, and results of operations for the fiscal years ended September 30, 2022 and October 1, 2021 are set forth below.

Comparison of Results of Operations for Fiscal Year 2022 and 2021

Revenues, net

[[GREPCENT_TABLE]]
[["(In millions)","2022","","% Change","","2021","","% Change","","2020"],["Medical","$","674.7","","","5%","","$","643.8","","","10%","","$","584.5"],["Industrial","184.7","","","6%","","174.3","","","13%","","153.8"],["Total revenues, net","$","859.4","","","5%","","$","818.1","","","11%","","$","738.3"],["Medical as a percentage of total revenues","78.5","%","","","","78.7","%","","","","79.2","%"],["Industrial as a percentage of total revenues","21.5","%","","","","21.3","%","","","","20.8","%"]]
[[/GREPCENT_TABLE]]

    Medical revenues increased $30.9 million in fiscal year 2022 compared to 2021 primarily due to increased sales of X-ray tubes and digital detectors for CT, oncology and dental applications in fiscal year 2022.

    Industrial revenues increased $10.4 million due to increased sales of X-ray tubes for airport security and digital detectors for inspection applications in fiscal year 2022.

Revenues by Region

[[GREPCENT_TABLE]]
[["(In millions)","2022","","% Change","","2021","","% Change","","2020"],["Americas","$","273.3","","","2%","","$","268.5","","","5%","","$","255.0"],["EMEA","280.8","","","2%","","276.3","","","19%","","231.5"],["APAC","305.3","","","12%","","273.3","","","9%","","251.8"],["Total revenues, net","$","859.4","","","5%","","$","818.1","","","11%","","$","738.3"],["Americas as a percentage of total revenues","31.8","%","","","","32.8","%","","","","34.5","%"],["EMEA as a percentage of total revenues","32.7","%","","","","33.8","%","","","","31.4","%"],["APAC as a percentage of total revenues","35.5","%","","","","33.4","%","","","","34.1","%"]]
[[/GREPCENT_TABLE]]

    The Americas revenues increased $4.8 million in fiscal year 2022 compared to 2021 primarily due to increased sales of digital detectors, high voltage cables, and computer-aided detection software in fiscal year 2022. EMEA revenues increased $4.5 million primarily due to increased sales of X-ray tubes and security inspection systems and machines. APAC revenues increased $32.0 million primarily due to increased sales of OEM X-ray tubes and digital detectors in China.

Gross Profit

[[GREPCENT_TABLE]]
[["(In millions)","2022","","% Change","","2021","","% Change","","2020"],["Medical","$","210.5","","","4%","","$","203.2","","","49%","","$","136.4"],["Industrial","73.0","","","7%","","68.3","","","27%","","53.8"],["Total gross profit","$","283.5","","","4%","","$","271.5","","","43%","","$","190.2"],["Medical gross margin","31.2","%","","","","31.6","%","","","","23.3","%"],["Industrial gross margin","39.5","%","","","","39.2","%","","","","35.0","%"],["Total gross margin","33.0","%","","","","33.2","%","","","","25.8","%"]]
[[/GREPCENT_TABLE]]

    Gross profit increased $12.0 million in fiscal year 2022 compared to 2021. The Medical segment gross profit in 2022 increased $7.3 million primarily due to the increased sales of CT X-ray tubes and oncology modalities partially offset by higher freight and material costs. The Industrial segment gross profit in 2022 increased $4.7 million primarily as a result of increased sales of digital detectors for dynamic imaging applications and non-destructive inspection applications, partially offset by higher freight and material costs.

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Operating Expenses

[[GREPCENT_TABLE]]
[["(In millions)","2022","","% Change","","2021","","% Change","","2020"],["Research and development","$","77.0","","","7%","","$","71.9","","","(9)%","","$","78.9"],["As a percentage of total revenues","9.0","%","","","","8.8","%","","","","10.7","%"],["Selling, general and administrative","$","118.3","","","(6)%","","$","125.5","","","(12)%","","$","142.2"],["As a percentage of total revenues","13.8","%","","","","15.3","%","","","","19.3","%"],["Impairment of intangible assets","$","\u2014","","","\u2014%","","$","\u2014","","","(100)%","","$","2.8"],["As a percentage of total revenues","\u2014","%","","","","\u2014","%","","","","0.4","%"],["Operating expenses","$","195.3","","","(1)%","","$","197.4","","","(12)%","","$","223.9"],["As a percentage of total revenues","22.7","%","","","","24.1","%","","","","30.3","%"]]
[[/GREPCENT_TABLE]]

Research and Development

    Research and development costs for fiscal year 2022 increased to 9.0% of revenues primarily due to increased spending on material costs supporting research and development initiatives and includes $1 million in costs related to a development agreement entered into during the fourth quarter of fiscal year 2022 with a third-party company. See Note 12, Commitments and Contingencies, included in the accompanying Notes to Consolidated Financial Statements. 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 13.8% for fiscal year 2022 from 15.3% for fiscal year 2021 due to lower compensation costs and higher revenue.

Interest and Other Expense, Net

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

[[GREPCENT_TABLE]]
[["(In millions)","2022","","% Change","","2021","","% Change","","2020"],["Interest income","$","0.4","","","300%","","$","0.1","","","\u2014%","","$","0.1"],["Interest expense","(39.8)","","","(5)%","","(42.1)","","","34%","","(31.4)"],["Other expense, net","(4.3)","","","23%","","(3.5)","","","(54)%","","(7.6)"],["Interest and other expenses, net","$","(43.7)","","","(4)%","","$","(45.5)","","","17%","","$","(38.9)"]]
[[/GREPCENT_TABLE]]

    Interest and other expense, net decreased in fiscal year 2022 compared to fiscal year 2021. Interest income increased primarily due to an increase in investments made into marketable debt securities. Interest expense decreased due to the redemption of $27 million of our Senior Secured Notes in March 2022 and the redemption of $30 million of our Senior Secured Notes in July 2021, as well as reduced fees on the ABL Facility.

Taxes on Income

[[GREPCENT_TABLE]]
[["","Fiscal Years"],["","2022","","2021"],["Effective tax rate","30.8","%","","37.4","%"]]
[[/GREPCENT_TABLE]]

    We had an income tax expense of $13.7 million and an income tax expense of $10.7 million, for effective rates of 30.8% and 37.4%, for fiscal years 2022 and 2021, respectively.

    During fiscal year 2022, our effective tax rate varied from the U.S. federal statutory rate of 21% primarily due to the unfavorable impact of profit in foreign jurisdictions with statutory tax rates greater than 21% and also U.S. deferred tax attributes and losses in certain foreign jurisdictions for which a valuation allowance is provided. These unfavorable items were partially offset by the favorable impact of U.S. tax reform regarding international provisions, return to provision adjustments, and R&D tax credits.

    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 was recognized and a reduction in benefit for U.S. net operating losses carried back to prior years. These unfavorable items were partially offset by the favorable impact of R&D tax credits and U.S. tax reform regarding international provisions.

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    We estimated the fiscal year 2022 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 2022 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 are sufficient to meet our anticipated operating cash needs for at least the next 12 months and will be sufficient to allow us to continue to invest in our existing businesses, consummate strategic acquisitions and manage our capital structure on a short and long-term basis. We are currently not aware of any trends or demands, commitments, events, or uncertainties that will result in or that are reasonably likely to result in our liquidity increasing or decreasing in any material way that will impact our capital needs during or beyond the next 12 months. See Item 1A. “Risk Factors” for a further discussion. The maximum availability under our ABL Facility was $100.0 million as of September 30, 2022; however, the borrowing base under the ABL Facility fluctuates from month-to-month depending primarily on the amount of eligible accounts receivable and inventory. As of September 30, 2022 the amount available under our ABL Facility was $94.5 million, and the ABL Facility remained undrawn. At September 30, 2022 we had $412.3 million in long-term debt, net of discounts and deferred issuance costs of $35.3 million.

    On March 18, 2022, the Company redeemed $27 million of principal of our $270.0 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 $28.7 million, inclusive of the redemption premium and accrued interest, and recognized a $1.2 million loss related to the redemption premium and the write-off of previously recorded debt issuance costs. See Note 9, Borrowings, in the accompanying Notes to Consolidated Financial Statements for more information regarding our indebtedness.

    Our consolidated cash and cash equivalents decreased from $144.6 million as of October 1, 2021, to $89.4 as of September 30, 2022. This decrease was primarily due to capital expenditures of $21.3 million, debt repayments of $29.4 million, and net purchases of marketable debt securities of $16.7 million and certificates of deposit of $7.2 million, offset by cash inflows from operating activities of $16.9 million and $4.9 million in proceeds from shares issued under employee stock purchase plan.

Cash and Cash Equivalents, Certificates of Deposit, and Marketable Debt Securities

    The following table summarizes our cash and cash equivalents, certificates of deposit, and marketable debt securities:

[[GREPCENT_TABLE]]
[["(In millions)","September 30, 2022","","October 1, 2021","","$ Change","","% Change"],["Cash and cash equivalents","$","89.4","","","$","144.6","","","$","(55.2)","","","(38.2)","%"],["Marketable debt securities not included in cash and cash equivalents","16.7","","","\u2014","","","16.7","","","100.0","%"],["Certificates of deposit not included in cash and cash equivalents","7.2","","","\u2014","","","7.2","","","100.0","%"],["Total","$","113.3","","","$","144.6","","","$","(31.3)","","","(21.6)","%"]]
[[/GREPCENT_TABLE]]

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Borrowings

    The following table summarizes the changes in our debt outstanding:

[[GREPCENT_TABLE]]
[["(In millions, except for percentages)","September 30, 2022","","October 1, 2021","","$ Change","","% Change"],["Current maturities of long-term debt"],["Current portion of other debt","$","2.1","","","$","2.8","","","$","(0.7)","","","(25.0)","%"],["Total current maturities of long-term debt:","$","2.1","","","$","2.8","","","$","(0.7)","","","(25.0)","%"],["Non-current maturities of long-term debt:"],["Convertible Senior Unsecured Notes","$","200.0","","","$","200.0","","","$","\u2014","","","\u2014","%"],["Senior Secured Notes","243.0","","","270.0","","","(27.0)","","","(10.0)","%"],["Other debt","4.6","","","7.8","","","(3.2)","","","(41.0)","%"],["Total non-current maturities of long-term debt:","$","447.6","","","$","477.8","","","$","(30.2)","","","(6.3)","%"],["Unamortized issuance costs and debt discounts"],["Unamortized discount - Convertible Notes","$","(28.7)","","","$","(37.6)","","","$","8.9","","","(23.7)","%"],["Unamortized issuance costs - Convertible Notes","(3.1)","","","(4.1)","","","1.0","","","(24.4)","%"],["Debt issuance costs - Senior Secured Notes","(3.5)","","","(4.4)","","","0.9","","","(20.5)","%"],["Total","$","(35.3)","","","$","(46.1)","","","$","10.8","","","(23.4)","%"],["Total debt outstanding, net","$","414.4","","","$","434.5","","","$","(20.1)","","","(4.6)","%"]]
[[/GREPCENT_TABLE]]

Cash Flows

[[GREPCENT_TABLE]]
[["","Fiscal Years"],["(In millions)","2022","","2021","","2020"],["Net cash flow provided by (used in):"],["Operating activities","$","16.9","","","$","92.6","","","$","13.2"],["Investing activities","(48.4)","","","(16.2)","","","(26.9)"],["Financing activities","(23.8)","","","(32.3)","","","83.6"],["Effects of exchange rate changes on cash and cash equivalents","(0.2)","","","(0.1)","","","0.9"],["Net (decrease) increase in cash and cash equivalents","$","(55.5)","","","$","44.0","","","$","70.8"]]
[[/GREPCENT_TABLE]]

    Net cash provided by operating activities. Net cash provided by operating activities was $16.9 million and $92.6 million for the fiscal years 2022 and 2021, respectively. The decrease in cash provided by operating activities was primarily due to increased purchases of inventory during fiscal year 2022.

    Net cash used in investing activities. Cash used in investing activities was $48.4 million and $16.2 million for the fiscal years 2022 and 2021, respectively. The increase in cash used in investing activities was primarily due to the purchase of investments and higher capital spending during the twelve months ended September 30, 2022.

    Net cash (used in) provided by financing activities. Net cash used in financing activity for the twelve months ended September 30, 2022, was $23.8 million and was primarily due to our early redemption of $27 million of our Senior Secured Notes. Net cash used in financing activities for the twelve months ended October 1, 2021, was $32.3 million and was primarily due to our early redemption of $30 million of our Senior Secured Notes.

Days Sales Outstanding

    Trade accounts receivable days sales outstanding (“DSO”) was 68 days and 62 days at September 30, 2022 and October 1, 2021, 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.

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Contractual Obligations

    The following table summarizes, as of September 30, 2022, the total amount of future payments due in various future periods:

[[GREPCENT_TABLE]]
[["","Payments Due by Period"],["(In millions)","Total","","Fiscal Year 2023","","Fiscal Years 2024-2025","","Fiscal Years 2026-2027","","Beyond"],["Lease obligations","$","26.9","","","$","5.4","","","$","9.1","","","$","5.9","","","$","6.5"],["Principal payments on borrowings","449.7","","","2.1","","","202.8","","","244.8","","","\u2014"],["dpiX fixed cost commitment","3.3","","","3.3","","","\u2014","","","\u2014","","","\u2014"],["Dividends to MeVis noncontrolling interest","3.1","","","0.4","","","0.9","","","0.9","","","0.9"],["Supplier equipment acquisition","2.5","","","2.5","","","\u2014","","","\u2014","","","\u2014"],["Development and share purchase commitments","6.6","","","6.6","","","\u2014","","","\u2014","","","\u2014"],["Total","$","492.1","","","$","20.3","","","$","212.8","","","$","251.6","","","$","7.4"]]
[[/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 Consolidated Financial Statements.

    For further discussion regarding our borrowings, see Note 9, Borrowings, included in the accompanying Notes to 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 2022, we estimate that we have fixed cost commitments of $3.3 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 Agreement, which we anticipate will continue for as long as we remain as the controlling shareholder of MeVis. As of September 30, 2022, 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 12, Commitments and Contingencies, included in the accompanying Notes to Consolidated Financial Statements.

    In the fourth quarter of fiscal year 2022, the Company entered into a development agreement and a share purchase agreement with a third-party company. For more information about these agreements, see Note 12, Commitments and Contingencies, included in the accompanying Notes to Consolidated Financial Statements.

Contingencies

    From time to time, we are a party to or otherwise involved in legal proceedings, government inspections, investigations, customs and duty audits, and other claims and contingency matters, both inside and outside the United States, arising in the ordinary course of its business or otherwise. We accrue amounts for probable losses, to the extent they can be reasonably estimated, that we believe are adequate to address any liabilities related to legal proceedings as well as other loss contingencies that we believe 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. We did not have any material contingent liabilities as of September 30, 2022 and October 1, 2021. Legal expenses are expensed as incurred.

    See Part 1, Item 3 of this Annual Report for additional information regarding legal proceedings and Note 12, Commitments and Contingencies, in the Notes to Consolidated Financial Statements for further information regarding certain of our contractual obligations and contingencies, which discussion is incorporated herein by reference.

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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. Note 1, Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements, Item 8 of this Form 10-K describes the significant accounting policies and methods used in the preparation of the Company’s consolidated financial statements. 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, net

    Inventory is valued at the lower of cost or net realizable value. Costs include materials, labor, external service 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 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 that 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 2022, 2021 and 2020, 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.

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    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 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.

    During fiscal year 2022, the Company received cash tax refunds related to net operating loss carryback claims for U.S. losses incurred in fiscal year 2020. On August 16, 2022, the Inflation Reduction Act was enacted in response to rising inflation. The Company does not meet financial statement thresholds for the minimum tax applicability and does not anticipate other provisions will have a material impact. The 2017 Tax Cuts and Jobs Act included a provision requiring research and development expenditures to be capitalized for tax years beginning after December 31, 2021, which is effective for the Company starting in fiscal year 2023. The Company has a significant amount of research and development expenditures and expects increased cash taxes in the early effective years related to this provision.

Recent Accounting Standards or Updates Not Yet Effective

    See Note 1, Summary of Significant Accounting Policies, of the Notes to 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 September 30, 2022 was approximately $425 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.

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