Executive Summary / Key Takeaways

• Varex Imaging is executing a fundamental margin recovery that the market has yet to recognize, expanding non-GAAP gross margins by 230 basis points to 35% in fiscal 2025 despite absorbing 100-150 basis points of tariff headwinds, while simultaneously achieving its lowest net debt leverage ratio (1.8x) as a public company.

• The Industrial segment has crossed an inflection point, delivering its highest quarterly revenue ever ($77 million in Q4) and representing 34% of total sales, transforming Varex from a medical component supplier into a diversified imaging technology provider with higher-margin, faster-growing systems business.

• China's tariff investigations have been indefinitely paused and customer order patterns normalized, removing a critical overhang that caused a $20 million Q3 revenue hit, with management now modeling China as flattish in 2026 rather than declining—a material de-risking of the primary bear case.

• Trading at 0.86x enterprise value to revenue versus diversified healthcare imaging peers at 1.71-2.14x, Varex's valuation fails to reflect its improving margin structure, de-risked balance sheet, and expanding addressable market in security screening ($1 billion+ annual serviceable opportunity).

• The success of the investment thesis hinges on two execution variables in 2026: scaling cargo systems production beyond the $55 million bookings achieved in fiscal 2025, and ramping the India manufacturing facility to drive cost leadership in value-tier radiographic components against Asian competitors.

Setting the Scene: The Independent Supplier Advantage

Varex Imaging Corporation, incorporated in 2016 and headquartered in Salt Lake City, Utah, exists because of a pivotal strategic decision by Varian Medical Systems to spin off its imaging components business. This January 2017 separation transferred critical intellectual property agreements and created the only independent, pure-play supplier of X-ray imaging components with global scale. Unlike vertically integrated giants such as GE HealthCare and Siemens Healthineers that manufacture components primarily for their own systems, Varex supplies the entire OEM ecosystem, turning what appears to be a competitive disadvantage into a durable moat.

The business model is built on engineered stickiness. Varex's X-ray tubes and flat panel detectors are never off-the-shelf commodities; they are tightly integrated, customized components that OEMs design their imaging systems around. With over 160,000 X-ray tubes and 170,000 detectors installed globally, the replacement and service revenue stream creates predictable cash flows that buffer cyclical downturns. This installed base generates switching costs so high that winning a design-in effectively locks in a revenue stream for a decade. The company's value proposition isn't just component performance—it's the total cost of ownership advantage that comes from demonstrated reliability in high-throughput medical and harsh industrial environments.

Strategically, Varex occupies a unique position in the imaging value chain. While healthcare conglomerates view components as a cost center to be vertically integrated, Varex treats them as the entire business, driving innovation cycles that outpace larger rivals distracted by complete system integration. This specialization enabled the company to capture 40% of medical revenue from CT modalities and expand into adjacent markets like cargo inspection systems, where vertically integrated competitors lack the agility to compete. The Industrial segment's 10% growth versus Medical's 2% in fiscal 2025 isn't accidental—it reflects a deliberate diversification strategy that leverages core competencies into higher-margin, less-cyclical security applications.

Technology, Products, and Strategic Differentiation

Varex's competitive advantage rests on a vertically integrated manufacturing philosophy that competitors cannot easily replicate without disrupting their core systems businesses. The Industrial segment's cargo inspection systems exemplify this: a typical installation requires a Linatron X-ray linear accelerator (high-energy source), photon counting detectors, image acquisition software, and electromechanical framework—all built in-house at facilities in Stoke-on-Trent (UK) and Las Vegas. This integration delivers a 35.9% gross margin that exceeds the Medical segment's 33.8% while enabling system-level pricing power that component-only suppliers cannot command.

The photon counting detector program reveals Varex's technology roadmap and its thesis implications. Unlike traditional energy-integrating detectors, photon counting technology offers superior material discrimination and dose efficiency—critical differentiators as OEMs develop next-generation CT systems. While Siemens Healthineers leads in photon-counting CT scale, Varex's strategy is multi-pronged: securing design-ins with multiple OEMs (not betting on one system), collaborating with academic institutions like Technical University of Munich, and commercializing industrial variants like the THOR detector for EV battery inspection. This matters because it diversifies technology risk; success doesn't require beating Siemens in medical CT but rather capturing value across medical and industrial applications where Siemens doesn't compete.

The $55 million in cargo systems bookings during fiscal 2025 demonstrates the economic impact of moving up the value chain. Each system sale includes hardware (30-40% margin) followed by 18-24 month transition to service contracts with "much higher margins," creating a recurring revenue stream that improves blended margins over time. Management estimates the annual serviceable market at over $1 billion growing at 7% CAGR, yet Varex's systems revenue is currently below $75 million annually—implying massive runway. The strategic implication is profound: cargo systems are margin-accretive to the Industrial segment once quarterly revenue exceeds $10-15 million, a threshold Varex approached in Q4 with $77 million total Industrial revenue.

India expansion represents a structural cost advantage in the making. The Vizag detector factory began ramping production in late fiscal 2025, targeting value-tier radiographic components where Varex faces intense competition from Asian manufacturers like iRay and Jiangsu CareRay. By localizing manufacturing, Varex can compete on price while maintaining margin—a critical capability as Chinese OEMs expand globally and price becomes paramount in tender decisions. The facility's expansion to enable greater vertical integration will drive further product cost reductions, providing a tailwind to Medical segment margins that have already expanded 340 basis points year-over-year despite tariff pressures.

Financial Performance & Segment Dynamics

Fiscal 2025 results provide compelling evidence that Varex's strategy is working. Total revenue of $845 million grew 4% year-over-year, but the composition shift tells the real story. Industrial revenue surged 10% to $252 million while Medical grew only 2% to $593 million, driven by higher CT, oncology, and mammography sales offset by radiography, veterinary, and dental declines. This mix shift improved overall non-GAAP gross margin to 35%, up 230 basis points, as the higher-margin Industrial segment gained weight. More importantly, the Medical segment's gross margin expanded to 33.8% from 30.4%—proof that operational improvements (material cost reductions, productivity gains) are working even in the legacy business.

The third quarter's $93.9 million goodwill impairment, though alarming on the surface, actually supports the thesis when properly contextualized. The charge was driven by a sustained decrease in stock price and downward revisions to long-term forecasts that included tariff impacts and MOFCOM investigations—both of which have since materially improved. Management explicitly warned that Medical reporting unit goodwill "remains susceptible to future impairment," but the indefinite pause of China investigations and resumption of customer orders indicate the impairment may have marked the nadirs of both sentiment and fundamentals. The stock's subsequent performance suggests the market over-discounted these risks.

Balance sheet transformation has been equally dramatic. By issuing $125 million in additional Senior Secured Notes in December 2024 and using combined proceeds to repay the $200 million convertible notes in June 2025, Varex reduced its effective interest rate and extended maturities. Net debt leverage fell to 1.8x EBITDA—the lowest level in the company's public history—while interest expense drops to $29-30 million annually, freeing up $15-20 million in cash flow compared to prior years. CFO Shubham Maheshwari's guidance that gross debt will target the "$300 million to $350 million range" implies further de-leveraging ahead, positioning Varex to refinance its 2027 notes from a position of strength.

Working capital management validates operational discipline. Days Sales Outstanding improved to 62 days from 70 year-over-year, while inventory write-downs decreased to $3.8 million from $4.9 million. These improvements occurred despite building inventory to meet anticipated demand, demonstrating that Varex is not stuffing channels but rather preparing for confirmed orders. The Industrial segment's $55 million cargo backlog provides visibility, while Medical customers' projections of stronger 2026 orders suggest inventory builds are justified.

Outlook, Guidance, and Execution Risk

Management's fiscal 2026 guidance frames a compelling investment narrative: "At this point, the demand environment looks to be solid. We expect full-year revenues to grow. We are expecting the medical business to grow for the year. We also expect the industrial business to grow." This dual-segment growth expectation, delivered after a year of tariff turmoil, signals that underlying demand is accelerating. The explicit modeling of China as "flattish" rather than declining removes the primary bear case catalyst, while the observation that "customers in China are now saying that they are seeing increased tender activity" suggests upside optionality if rural healthcare expansion materializes.

The first quarter fiscal 2026 guidance—revenue of $200-215 million and non-GAAP gross margin of 32-34%—appears conservative given Q4's $229 million revenue and 35% margin. Management attributes the margin outlook to continued 100-150 basis point tariff headwinds, but this is already baked into expectations. The critical insight is that Varex has demonstrated ability to pass through tariff costs to customers, having "started to charge our customers already for the tariffs" in fiscal 2025. This pricing power, combined with India localization efforts, means tariff impacts are transitional rather than structural—a nuance the market has missed.

Three execution variables will determine whether the thesis unfolds as envisioned. First, cargo systems must scale production to convert $55 million in bookings into recurring service revenue. Management plans to "scale up production capacity...in fiscal 2026," and the segment's Q4 performance suggests this is achievable. Second, the India detector factory must ramp efficiently to enable cost-competitive radiographic components; any delays would cede share to Asian competitors in value-tier markets. Third, photon counting CT requires securing additional OEM design-ins beyond anchor customers to ensure Varex isn't bypassed as Siemens and GEHC scale their proprietary systems.

Management's commentary on competition provides strategic context. When asked about GE selling its China business and Siemens splitting operations, CEO Sunny Sanyal responded that "the vast majority of our business in China comes through our Chinese OEMs" and that these developments "really do not have any significant implications for us." This matters because it highlights Varex's insulation from Western OEMs' China troubles while benefiting from Chinese OEMs' global expansion. The company's position as an independent supplier becomes more valuable as geopolitical fragmentation accelerates.

Risks and Asymmetries

Tariff escalation remains the most visible risk, with management stating that "absent a de-escalation...tariffs have and are expected to continue to negatively impact our business." The 100-150 basis point headwind persists, but the asymmetry favors investors: tariffs are already reflected in guidance, any reduction provides immediate margin expansion. More importantly, Varex's mitigation strategies—localization, bonded warehouses, and cost pass-through—demonstrate operational resilience that wasn't present two years ago.

Customer concentration creates genuine vulnerability. Canon represents 18% of total revenue, and the top five customers account for approximately 40%. If a major OEM like Canon (CAJ) or Philips were to vertically integrate or shift to a competitor like iRay Technology, Varex would face a revenue cliff. The mitigating factor is the installed base: replacement tubes and detectors must meet exact specifications, and switching requires costly system requalification. The risk is most acute in new system design-ins, where Varex must continuously win each next-generation platform.

Technology disruption cuts both ways. While photon counting CT represents a growth driver, Siemens' head start and superior scale could relegate Varex to a niche supplier role. The company's THOR industrial detector shows it can innovate outside medical, but if photon counting adoption accelerates faster than Varex can scale, the Medical segment's 40% CT revenue exposure could face share loss. Conversely, success in securing design-ins would validate Varex as a technology leader rather than a commodity supplier, justifying multiple expansion.

The goodwill impairment risk is more than technical accounting. Management explicitly stated that "any significant adverse change in the Company's near- or long-term projections or macroeconomic conditions would result in future impairment charges." With $93.9 million already written off and the Medical unit's margins improving, further impairment would signal a fundamental deterioration in the business outlook. Monitoring Q1 2026 Medical margin trends will provide early warning.

Valuation Context

Trading at $11.21 per share, Varex carries a market capitalization of $467 million and enterprise value of $728 million (including $215 million net debt). The EV/revenue multiple of 0.86x stands at a stark discount to healthcare imaging peers: GE HealthCare (GEHC) trades at 2.14x, Philips (PHG) at 1.85x, and Siemens Healthineers (SHL) at 1.71x. This 50-60% valuation gap persists despite Varex's improving margin profile and comparable technology in core components.

The price-to-free-cash-flow ratio of 11.82x appears reasonable for a company generating $18.8 million in annual free cash flow while investing in growth initiatives. More importantly, the forward P/E of 16.73x suggests profitability normalization after the goodwill-impacted fiscal 2025. The company's return on assets of 3.56% lags GEHC's 5.46% and Siemens' 4.37%, reflecting smaller scale, but the gap is narrowing as operational leverage takes hold.

Balance sheet strength provides valuation support that wasn't present pre-spin-off. Net debt leverage of 1.8x EBITDA is the lowest in Varex's public history, with $155 million in cash and $155 million available on the revolver providing ample liquidity. Management's target of $300-350 million gross debt implies further de-leveraging of $20-70 million, which would reduce annual interest expense and improve equity valuation directly.

The valuation disconnect becomes more apparent when isolating the Industrial segment. With $252 million in revenue growing at 10% and generating 35.9% gross margins, a comparable security and inspection business would command a premium multiple. Even assuming a conservative 1.5x revenue multiple—still below diversified peers—the Industrial segment alone would be valued at $378 million, leaving the Medical segment (with $593 million revenue and improving margins) valued at essentially zero. This sum-of-parts analysis suggests the market has not internalized the diversification strategy's success.

Conclusion

Varex Imaging's fiscal 2025 results tell a story of resilience and transformation that the market has yet to price. The company absorbed bilateral tariff shocks, repaid $200 million in convertible debt, expanded gross margins by 230 basis points, and grew its Industrial segment to record levels—all while maintaining technology leadership in next-generation photon counting detectors. The indefinite pause of China investigations and normalization of customer order patterns remove the primary overhang that justified prior valuation discounts.

The investment thesis rests on three converging factors: margin expansion driven by Industrial mix shift and operational improvements; balance sheet de-risking that frees up $15-20 million in annual cash flow; and valuation at half the revenue multiple of peers despite comparable technology and improved financial metrics. The asymmetry is clear—downside appears limited by the de-risked balance sheet and flattish China outlook, while upside depends on execution of tangible initiatives (cargo systems scaling, India ramp, photon counting design-ins) already in motion.

What will determine success in 2026 is not macro factors but operational execution. Can Varex convert $55 million in cargo bookings into quarterly revenue exceeding the $10-15 million threshold where margins inflect? Will the India facility enable share gains in value-tier radiography against Asian competitors? Does photon counting CT secure enough OEM design-ins to offset potential share loss in traditional detectors? These variables are measurable and manageable, making Varex a compelling story of self-help transformation at an attractive entry point.