Varex Imaging Corporation (VREX) Q3 2017 Earnings Report, Transcript and Summary

Welcome to the Varex Imaging Third Quarter Fiscal Year 2017 Earnings Call. [Operator Instructions]. As a reminder, this conference is being recorded. It is no pleasure to introduce Howard Goldman, Director of Investor Relations. Thank you. You may begin.

Good afternoon, and welcome to our Conference Call for the Third Quarter of Fiscal Year 2017. With me today are Sunny Sanyal, our President and CEO; and Clarence Verhoef, our CFO. To simplify our discussions, unless otherwise stated, all references to the quarter or year are fiscal year or fiscal quarters. Quarterly comparisons are for the third quarter of fiscal year 2017 versus the third quarter of fiscal 2016, unless otherwise stated. Year-to-date comparison are for the first 3 months of fiscal year 2017 -- sorry first three quarters fiscal 2017 versus the 3 quarters of fiscal year 2016 unless otherwise stated. Comparable financial statement for fiscal year 2016 and the first quarter of fiscal year 2017 reflect operating results for the Imaging Components business of Varian Medical systems, prior to our separation, and include estimates of cost allocations for various corporate functions, interest expense and tax expense. Additionally, third quarter and year-to-date financial statements for fiscal year 2017 reflect 2 months of operating results for the imaging business we acquired from PerkinElmer on May 1, 2017. In addition, beginning with financial results for the third quarter of fiscal year 2017, we will supplement our consolidated financial statements compared in accordance with U.S. generally accepted accounting principle or GAAP with the use of adjusted or non-GAAP financial measures of certain elements of financial performance. These adjusted measures are not presented in accordance with nor are they substitute for GAAP financial measures. These adjusted measures include adjusted gross margin, adjusted operating earning, adjusted operating earnings margin, adjusted net earnings and adjusted net earnings per diluted share. We provide a reconciliation of each adjusted financial measure to the most directly comparable GAAP financial measure used in our earnings press release issued earlier today which is posted on our website. We are unable to provide without unreasonable effort a reconciliation of adjusted guidance measures to the corresponding GAAP measures on a forward looking basis due to the potential significant variability and the limited visibility off the exclusive items discussed. Please be advised that this discussion contained forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Our use of words and phrases such as believe, estimate, expect, anticipate, could, will, potential, outlook and similar expressions are intended to identify those statements, which represent our current judgment on future performance or other future matters. While we believe them to be reasonable based on information currently available to us, these are forward looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those anticipated risk relating to our business are described in our third quarter earnings release and in our filings with the SEC. The information in this discussion speaks of -- speaks as of today's date and we assume no obligation to update or revise the forward-looking statements in this discussion because of new information, future events or otherwise. And now I'll turn the call over to Sunny.

Thank you, Howard. Good afternoon, and welcome to our first full quarterly earnings conference call as a public company. This quarter also includes 2 months of results from the recently acquired PerkinElmer imaging business which naturally makes a lot of moving pieces, to give you more clarity starting this quarter we're including adjusted financial measures with our results, which we believe will provide investors with an additional valuable information about the performance of our business. Let me first start with a summary of our financial results for the third quarter. A little later, Clarence will discuss our results in more detail. Revenues increased 12% to $170 million, including $27 million from the acquired imaging business. And were up 8% for the trailing 4 quarters. For the third quarter, organic revenues declined 5%, up 3% for the trailing 4 quarters. In the third and fourth quarters of last year, we strong year-over-year revenue growth as our business started to recover from an earlier downturn. This makes challenging comps in the second half of this fiscal year. Now our Medical segment, we've seen strong year-to-date growth in the mammography and dental markets and stability in the CT, radiographic and fluoroscopic markets. However, sales of our non-OEM aftermarket X-ray tubes to third-party service organization declined. We continue to experience good growth in our connective control business for a high-voltage connectors and other accessory components. In the industrial segment, growth in the security market contributed to increase revenue during the quarter. This sector is comprised of fort and border protection as well as airport security both of which delivered growth during the quarter and year-to-date. We are working with that OEM customers on new development projects to improve throughput and effectiveness of airport screening for carrion and check baggage. We expect to see these areas as longer-term opportunities for us. Net earnings were $11 million, or $0.28 per diluted share compared to a net earnings of $18 million or $0.47 per diluted share. Adjusted net earnings were $17 million or $0.44 per diluted share compared to adjusted net earnings of $19 million or $0.49 per diluted share. The reduced profitable was primarily due to lower gross margin. Now let me shift to operations. Our most significant accomplishment during the quarter was the completion of the acquisition of the PerkinElmer imaging business. This acquisition adds a significant revenue stream, new customers and new technologies and technical expertise. Along with a strong brand and expanded footprint in the Industrial sector. In a few minutes, Clarence will discuss financial details and also provide color around revenue and cost synergies. In the meantime, I'd like to update on our integration activities. First of all, immediately out of the gates, we integrated that acquired imaging businesses sales team into the various organization. We also completed the work to rationalize digital detector offerings any overlapping R&D projects. For the combined businesses we have clear product positioning for each modality and the combined sales team is now focused on the full Varex product portfolio. We helped corporate level breathings for our newly added customers including the two new anchor customers GEN Electra and introduce them to our business. We also use these meetings to discuss activity supply them with broad range of our extra products. Derivation teams have already begun comparing best practices and product design, supply chain management and manufacturing and have identified opportunities for productivity improvements. We have initiated projects to leverage each other's capabilities on assets and the areas of scintillators and glass fabrication which you believe will generate future cost savings and provide customers with high-performing products. In summary, that integration efforts are well underway and I'm very happy with our progress. During the quarter, we also completed verification and validation of 4 new detector products for floor radiographic markets. Customers are currently evaluating prototypes of these digital detectors, for an inclusion in the development of their future new systems. Lastly, during the third quarter, we reached a significant milestone with the production of our 100,000 Varex Digital Detector. As the frame will reference, in 2004, we produced 327 units, and this fiscal year we are on track to produce over 21,000 units. Including the acquired imaging business, we estimate that Varex has approximately 150,000 digital detectors in service around the world, which is about a third of the detectors in use globally switching over to our X-ray tube products. We continue to innovate in order to bring new X-ray tubes and sources to market, while looking for rates to expand our product offerings. During the third quarter, we launched a new integrated CT solution that combined multiple components. This integrated package incorporates a CT tube, generator, high-voltage connectors, heating exchanger and tube control units. We expect this solution to be attractive to OEMs who are looking to accelerate their time to market with new CT systems. While an average CT tube consult for $25,000 to $45,000, we are expecting this integrated solution to potentially sell for $80,000 to $100,000. We are additionally, bring integrated solution to new OEMs in emerging markets, particularly China, to help them shorten their time to market for seeking imaging systems. Our strategy is to offer both, standalone best to breath components as well as integrated suites. Over time, we plan to expand these types of product offerings to a broader range of OEM customers and modalities. As we have said previously, China is one of the long-term growth drivers for a business. Our revenues there are currently less than 10% of the total company revenues. We have been investing in our development targeted at the Chinese market and we are making excellent progress there. In fact I'm pleased to announce that we have find a new pricing agreement with a major OEM in China, for purchases of our CT x-ray tubes. We expect this agreement to generate $70 million to $80 million in revenues over the next three years. The Chinese government has made a commitment to expand health care services beyond urban areas, to the rest of very large country and views CT as one of the imaging modalities of choice, because of its versatility in diagnostics. CT in China is growing at more than 6% a year, compared to global growth of around 4%. I will now fit that estimate that China will need approximately 25,000 CT systems over the next 10 years. It also appears that the CT market in China is increasingly favoring local Chinese manufacturers. We believe that our ongoing development projects with local Chinese OEMs will drive significant growth for us over the coming years. In the near term, we expect to see a ramp up of revenues beginning in fiscal year 2018, as new systems are launched overtime. I'm also very pleased to say that we are continuing to expand our partnerships in the U.S. and in Europe. Earlier this year, GE and their strategic partner [indiscernible], introduced cardiograph, the world's first dedicated cardiovascular CT system. Cardiograph incorporates Varex's high end CT tubes, designed to produce high-quality images of the heart within one heartbeat. We're very excited to have this groundbreaking CT cubes inside this advanced cardiovascular CT system. With that, let me hand over the call to our CFO Clarence Verhoef, to talk about our financial performance in greater detail.

Thanks, Sunny and hello everyone. As Howard mention in the beginning, in the first half of 2017 as well as 2016, costs associated with the separation from Varian Medical System were included in our financial results. In the third quarter of 2017, we had the impact of a major acquisition as well as acquisition related costs. Are adjusted financials will exclude our usual items such as separation cost, restructuring cost and acquisition related costs to provide a clear representation of our ongoing operations. I will present the quarterly and year-to-date results both as reported i.e. as GAAP and as adjusted financials. Before I go into the details of financials when we summarize the P&L for the two months of the acquired imaging business that is included in our third quarter results. This acquisition add a $27 million of revenue, $9 million of gross margin at 36% and $4 million of operating expenses. We're quickly integrating this acquisitions into our business and will not be providing standalone detail after the end of fiscal year 2017. Over the coming years, we expect to see annual revenue growth in this acquired business from both market expansion and synergies from cross-selling opportunities. By fiscal year 2021, we expect to reach incremental annual revenues from synergy of approximately $20 million to $30 million. The timing of revenue's energies will depend on a number of factors including the customer validation process for new Imaging Components and multi-year developer cycles of customers new X-ray imaging systems. We expect to realize a number of cost synergies from this acquisitions through decreases in SG&A expenses, greater leverage on our manufacturing scale and supply chain cost reductions as well as rationalization of operations, products and R&D projects. By fiscal year 2021, we anticipate reaching annual cost savings of $15 million to $20 million. In fiscal year 2018, we're targeting approximately $5 million of cost savings. Now to our P&L. Our third quarter revenues were up 12% to $170 million from $151 million a year ago. Year-to-date revenues were up 8% to $482 million. Medical segment revenues increased 7% in the third quarter to $135 million and included $18 million from the acquired imaging business. For the quarter, the detector growth from the acquired imaging business was partially offset by revenue declines for CT tubes and aftermarket tubes. Year-to-date revenue were up 6% to $392 million. Industrial segment revenues for the third quarter increased 39% to $35 million and included $9 million from the acquired imaging business. Year-to-date revenues were up 17% to $90 million. We continue to see good growth in the security market which has delivered double-digit growth year-to-date for this group of projects. Our gross margin was $60 million in the third quarter, down from $63 million in the year-ago quarter. Our adjusted gross margin for the third quarter was $64 million compared to $63 million a year ago. As a percent of revenues, the adjusted gross margin was 38% compared to 42% a year ago. In the prior-year period, we had favorable mix of high-margin product sales and lower than average factory and quality cost. Year-to-date, our gross margin was 36% compared to 40% in the prior year. Our year-to-date adjusted gross margin was 38% compared to 40% in the prior year. The improvements in the third quarter gross margin over the first half of this year is encouraging and we still expect our long-term gross margin to be in the range of 38% to 40%. Our operating expenses in the third quarter were $44 million, up 27% from the year-ago period. R&D expenses were $18 million or 10.4% of revenues in the quarter, which increase from $14 million or 9.2% of revenues in the year-ago quarter. Year-to-date R&D expenses were 9.4% of revenues compared to 8.8% in the prior year. This increase was a result of higher prototype material cost primarily for CT X-ray tube development projects and a higher percentage of R&D spending in the acquired imaging business. We now expect R&D expense to be approximately 9% of revenues for the current fiscal year. Third quarter SG&A expenses increased to $26 million or 15.5% of revenues from $21 million or 13.6% of revenues in the prior year. The third quarter include $2 million of expenses from the acquired imaging business as well as $4 million of acquisition related cost. On an apples to apples basis, third quarter and year-to-date SG&A expenses were about 8% of revenues as in the prior year. During the quarter, we have lower administrative cost offset by higher international sales and marketing expenses. Depreciation and amortization totaled $8 million for the quarter compared to $4 million a year ago. Our operating earnings for the third quarter were $16 million, down from $28 million in the same quarter a year ago. Our operating margin was 9% in the third quarter, a decline from 19% in the year-ago quarter reflecting the acquisition related cost, and the decrees in the gross margin. For the third quarter our adjusted operating earnings were $24 million compared to $30 million in the prior year. The adjusted operating earnings margin was 14% compared to 20% in the prior year. Interest expense in the third quarter was $4 million compared to less than $1 million in the prior year. During the quarter, we had a $2 million gain in our minority investment in depix and a $2 million favorable adjustment for currency reevaluation due to a stronger euro. Net earnings for the third quarter were $11 million to $0.28 per diluted share, compared to net earnings of $18 million or $0.47 per diluted share in the prior year. For the third quarter, adjusted net earnings were $17 million or $0.44 per diluted share compared to $19 million or $0.49 per diluted share in the prior year. Our number of diluted shares outstanding has increased 1% to 38 million shares from 37.7 million shares in the prior year. I would summarize the quarter as mixed although, we were disappointed with our legacy revenues, we saw growth in industrial, benefiting from adding new acquisition, saw improved gross margin over the first half of this year and has some favorable items in other income and tax rate. Now turning to the balance sheet. We ended the third quarter with cash and cash equivalents of $89 million and grossed debt of $510 million. During the quarter, in connection with the acquisition, we increased our credit facility to $600 million and borrowed an additional $308 million under this facility to fund the acquisition and credit facility fees in other working capital needs. Separately, we established interest rate swaps that set a fixed rate of 4.2% on approximately $300 million of the outstanding LIBOR-based debt. Cash flow from operations in the third quarter was $31 million bringing the total cash flow from operations for the first 9 months of the current year to $64 million. Property plant in equipment additions were $1 million for the third quarter and $8 million for the year-to-date. Looking at our working capital, our cash receivable increased by $11 million during the quarter, due to the addition of the acquired imaging business offset by strong collections. Any sales outstanding improved by 4 days during the quarter to 66 days and bad to 65 days in the year-ago quarter. Inventory increased by $45 million during the quarter due to the addition of the acquired imaging business and ramp up of inventory and preparation for higher shipments during the fourth quarter. During our third quarter, our current liabilities increased by $12 million due to the addition of the acquired imaging business partially offset by a reduction in our obligation to Varian. Now moving on to our outlook for the remainder of this year. For the fourth quarter of fiscal year 2017, we expect revenues to grow by 23% to 26% including revenues from the acquired imaging business. For fiscal year 2017, we expect that revenues will grow by 12% to 13% over fiscal year 2016. Which includes approximately 9% to 10% of additional revenue from the acquired imaging business. Including the operational impact of the acquired imaging business and its related financing, we expect adjusted net earnings for the fourth quarter for fiscal year 2017 to be in a range of $0.50 to $0.54. For fiscal year 2017, we expect adjusted net earnings to be in a range of $1.73 to $1.77 per diluted share guides for our net earnings per diluted share is provided on an adjusted basis only. If adjusted financial measures is forward-looking and without unreasonable effort we're unable to provide a meaningful or accurate compilation of reconciling items to GAAP net earnings per diluted share due to the uncertainty of amounts and timings of unusual items. At this time, we would like to open the call for your questions.

[Operator Instructions]. Our first question comes from Lawrence Solow with CJS Securities.

Few questions. Can you just elaborate a little bit more on the organic declines in medical in quarter looks like it's about 7% to 8%. And if I do the math, it's look like you're predicting or your guidance to Q4 at least on an overall bases, has you returning to organic growth, I think of about 3% to 6%, so I assume, medical is also returning to positive. Can you just clarify those numbers in the ballpark and then discuss the declines in the quarter, you called out the non-OEM aftermarket suits to third-party sales, is that the hospitals for the replacement, or you can help us clarify, want you to add little more color that would be great?

This is Sunny. I'll clarify the last part of the question and turn it over to Clarence for further clarification. Most of our business come from OEM segment. It's very small portion of our tube sales go to the third-party sales service organizations or multi-vendor service organization who service a variety of equipment across many different manufacturers and we make aftermarket tube, what we call is after market tubes for a variety of manufacturers. So those are tubes that we make when we don't have an OEM arrangement with those particular manufactures. That segment was the one that I was referring to, when we saw the saw decline. And there it tends to be -- demand there tends to be volatile based on any level will of service activity or the amount of tubes that may have in circulation. So it's largely a drop in business. We did a call, we've tube, can you ship me one right now, that's how that portion of the business works. So that's where we saw the decline.

Is most of that business -- they are selling their tubes in the aftermarket that or are they are placement tubes?

These are not our replacement, these are all after market for third parties, other manufacturers. They're not all replacement tubes, correct. And also during the year-over-year impact, we had an impact from if you recall Toshiba had some adjustment last year they had a particularly strong quarter last year as they cut up on some of their inventory adjustments et cetera. So there was on a corresponding year-over-year basis, we saw some decline there. So those are the two reasons for extra tubes being down.

So let me add a little bit more to that I guess, because of the a little bit of a tough comp from a quarter ago -- from a year ago quarter, I think it's always important to look at this business and I've said this to you multiple times, which is that we look at this business on a longer term basis. So over trailing 4 quarters, we're still up 3%. So I think that's a good way to think of it from an organic perspective. I do think your numbers are about right for how you are looking at Q4 and for the year-to-date kind of information, so I think, that's accurate. The other piece, I guess, kind of around the aftermarket business that's also one of those things where there is a fair amount of aggressiveness, I'd say by those other manufacturers that are pushing hard in the market to retain their market share. Because that's fundamentally who we are competing with, its we're competing with the original manufacturers of those systems.

They are actually -- is there a price pressure on there's too or?

Certainly. That's certainly how they do it. They do it by combination of how we set pricing as well as how they may be bundled somethings together with other products that they have in-hospital and the like.

Obviously, this quarter obviously, called you by surprise, and it's lumpy, so I guess it's not easy to predict but does the quarter itself, is there any -- do you think there's a longer-term -- increase in competition or something that will -- it seems like it's pretty small piece of your business. Is that enough -- big enough change to where it's driving things down more prominently or permanently impaired or permanently impacted?

I do think, the key point there is, that it's not a large part of our business. But it is a little bit of drag for the entire year. We saw a little bit more in Q3 perhaps than in some of the other quarters but I think that's as part why it's getting discussed a little bit now as it's a little bit more of a full-year kind of impact rather than a single quarter.

So are you still sort of comfortable with your medical growth but over that may be your long-term -- your 3% target so whatever may be grow into a little bit above that overtime?

Let me kind of backup to even maybe more basic in that. The overall guidance for the year is still 3% to 4%. We're just more towards the lower end of the 3% to 4% than the upper end at this point in time. And you are right, I mean it's driven by two parts always, the medical and the industrial, and the industrial has done very well for us this year. And so that one is up more in the range of 4% to 5% for the year and so that's helping us a lot and then but the medical is still a longer-term as still at the, we're in a stake that's growing in 3% to 4% kind of range.

Okay, fair enough. And you do assume, you do incorporate some growth -- i know you can breakout medical and industrial for Q4 but do you assume 80% of your revenue being medical, I guess, you incorporate [indiscernible] growth based on your targets?

That's fair to say.

Just switching gears to Perkin and I'll get back in queue. If you could, two-part question, your characterize the cost synergies very well on a long-term. Can you just maybe help us sort of bucket what you -- what are sort of the near term things and then $5 million number and I assume, is that number by the end of '18. Then second question, if you can just on a revenue side, more higher level on the terms like that's take a longer bit -- most of those synergies just from cross selling?

Yes, so I'll touch on the cautionary side now and are turn it over to Sunny to talk about where the sales energy are. Cost synergies, and we're talking specifically, for 2018, we're targeting $5 million of cost savings in net support, not a run rate by the end of the year kind of thing, that's how much the savings would be in the year. And that's -- the starting point there is just leveraging SG&A to begin with. The level of SG&A is that we have to have in that business is not near the level of what they had when it was with a bunch of allocated cost, when it was part of PerkinElmer. So I think that's the biggest driver of cost reduction to begin with. And then as we start working on looking at the leveraging the scale with the conversations with the suppliers and also just looking at how to be more efficient in the manufacturing processes, those are things that we can see additional benefit as well. More outside of '18 then in '18 for the rest of that stuff.

So the revenue synergies, they occur over a longer period of time. The way to think about it is, there are two parts to it, in the near-term, near-term I characterize it as 2018, 2019, timeframe there are hot sales opportunities of some of the products that are simpler to integrate. Like for example, in the Industrial segment, to sell industrial tubes to PKI customers who buy their detectors. We expect to see self synergies from those in the short-neared term, where it doesn't involve much integration activity with OEMs. Longer-term, self synergies would come by way of incorporating each of those, the two product portfolios into each other's customer base. So for example, if we were to sell some other products to Electro or to GE, it would take them some time to integrate into their system and that's why the revenue synergies are over a longer period of time. This point, clearance of guidance of over four-year timeframe.

Our next question comes from Paul Coster with JPMorgan.

It's Mark Stratus [ph] on for Paul. I think we understand the rationale for switching to pro forma EPS guidance. It looks like on the revenue guidance of that pretty much looks unchanged. Are you able to high level of nothing else kind of compare, the prior GAAP EPS to this new per forma EPS guidance, has there been any material change in that number -- may be comparing contrast of what the per forma EPS guidance would have been if you would have been issuing that previously?

Yes. So Mark, let me -- I'm going just walk through that a little bit. So last quarter, we still were giving GAAP guidance and our guidance for the second half of the year was $0.69 to $0.79. the mid-point of that is $0.74. So let's just kind of talk a mid-point so that keep things a little simpler. To adjust that to non-GAAP or adjusted guidance, there is 2 key things. There is a small amount of adjustments for amortization of intangibles that are in the historical, Varex business and that would add $0.04 and that if you take the include impact of adding second half of the year of the acquired business, that adds $0.18. You have that $0.22 on top of the $0.74 midpoint and you now have a new midpoint non-GAAP or adjusted midpoint of $0.96. We had $0.44 in Q3, which we just reported, so that leaves $0.52 at the midpoint for Q4. And our range right now, is at $0.50 to $0.54. So basically, I'm saying that the guidance is unchanged. We are still at the same number.

Our next question comes from Bill Gabler with Seaport Global.

Three questions all about future business opportunities. Can you talk a little bit about where you see industrial going and potential growth there. Secondly, China, you said you signed a new contract that's good for $80 million, is there more that you can do in China? And third, I know that PKI is your last large M&A transaction. But are there others that you have been looking at?

Let me talk to the industrial. Let me talk about the industrial which is the non-medical segment. It has 2 big components to it. One is the industrial, destructive testing and the second one is security. So we see growth in both those sectors, security is driven, we've seen very good uptick in the security segment largely driven by overhaul of security systems at airports. There is a pretty strong drive to give CT-based systems implemented in airports. There's a new mandates to get CT systems in place by 2022 and that's driving adoption of CT systems for both hand baggage and check baggage. And our tubes are incorporate in those technologies across several different manufacturers. So we're going to see ongoing traction there driven by the market beats. Cargo based security inspection, which is an inspection of either your palletized cargo or trucks and boards and ports. That remains lumpy but there is ongoing adoption of X-ray technologies, so we expect over the long-term to see growth in that sector but the timing is always a challenge there and it's driven by tenders globally. So in industrial, we're bullish and industrial driven by the adoption of technologies and also driven by security. China is interesting in that. As we said before, we're engaged in Park development with may almost all the major OEMs that have revolved in China and almost every one of them is working on building CT systems and our CT technologies are being incorporated into their roadmaps. And will be expected over the next few years that in progressively, they will bring these CT systems to market. Already a couple of our customers have done that. This new contract referred to is one of those several OEMs, so this is we expect more these obviously from the other OEMs. We're very excited to see this to see this happen because it's both an affirmation of our the application market technologies, our success is those market segment. And we're getting brand recognition in that market. So that leads to OEMs bring new products to market, CT will be the first one, where we expect see traction followed by other modalities such as cardiovascular, the mammography digital radiography is already on its way. So we're bullish on the China market and we feel we're well-positioned there with the ongoing R&D activity, which started actually 3 to 4 years ago. And we've made quite a bit of investment there already. In the last point about PTI as an example of M&A. In our segment, there are lots of small players, a lot of technologies that we could look at. They are very few large companies and we have looked at, we're always looking and always evaluating opportunities here, at this point, what we would like to do is, either integrate PTI, do a good job there and bait on a bit of the debt, and then as far as use of our cash and our capital M&A is a high priority. We know most of the players, in this segment, there are deals that can be done, we have evaluated many of them, we just wanted to get through the PKI acquisition and then reopen our activity there at some time in the near future.

Great, thanks. Speaking of debt, are you comfortable carrying sort of any prominent debt load or would you expect pay everything down and debt free and look to do something further?

No. Our debt load right now, is a little bit north of 3x EBITDA and we would like to get it down to let's say 2x 2.5x, it doesn't need to be zero for us to be able to do that, could be looking at acquisitions.

The next question come from John Koller with Oppenheimer.

So you know my first question is going to be about quality and the gross margin. so anything you would like to add on that for the F Q3?

I would say that the gross margin, it's a good news bad news story. Because the good news is that we saw some improvement from where we were in the first half of the year. The bad news is that still little bit lower than what we would like it to be. And there's always -- when you think about gross margin, you always have to think about in two manners, one is the mix of what we're selling, because there is quite a bit variation between higher end products and the lower end lower margin products and, so that mix will impact us from quarter-to-quarter. And even year to year for that matter. And then as you touched on I think cost of quality for us is our yield in our factory and the efficiencies of our factory are the other factors that come into play. I would say that our level performance on cost of quality for this quarter was similar to the prior quarter. We had -- we gained a little bit this quarter because of product mix more than so much on the cost quality. So we still have opportunities, I think we have got dedicated people and dedicated programs focused on improving but those take a bit of time to do because it's very a lot of reengineering of how we do things.

Okay, great. Getting onto the $70 million to $80 million really quick in China. That's over what time period were you?

It's over 3-year time frame. We will start to see it realizing in the latter half of 2018. It ramp up through 2018 and then it's over a 3-year period.

We are doing some while there's a bit the volume of that not a large amount but there are some shipments that happen this quarter but that's relatively small.

Okay. And then to talk about the Perkin acquisition, you obviously, had expectations going in for what you wanted on a return basis. Now that you have it and you're working on it. What if you can share your current expectations for returns and whatever metric you one of talk about, and then with discrepancy or differences between then and now. And I'm mostly trying to drive at a return on capital or how you feel spending the money how you feel that's progressing?

Well, first of all, I think we are still early in the process. I mean we just, we closed that in May and so we've got two months of visibility under our belt and I would say that that's been favorable from what we've seen, pretty well in line with expectations. We talk about the gross margins of that business, we're going to be similar to ours and so on, they are at 36%, we're at 38%. So falls in that range. Again, for them that is also factor of product mix more than anything. And then the, in terms of returns, when I think about not probably give you specific number about expectations for returns on that yet. And will probably go into a little more color as we look at guidance for next year. But I would say that, what I'm seeing in term of where we are in terms of profitability of that business, very similar and if not even a little bit higher than our business. Somewhat because of the low amount of SG&A that they have or that we have to add associated with this business, so I think it's all in all it's been favorable in terms of our view where it's going. And our first indication does that are nothing but positive.

Let me at to that and say that, when we are doing the due diligence in acquisition our estimates of cost energies and sale synergies have not changed. We didn't, since they are competitors of our, it's only so much we could look, it detailed but once we've close the acquisition, the close all those gaps and there are no surprises that I can think at this point of other consequence or material.

We are happy about our assessment of the synergies.

Okay, great. And I know that when you do your R&D and your expenditures. You're looking our quite a bit, quite a number of years you're working on projects that are going to come to fruition in a longer time period. So I know R&D has ticked up a little bit, I'm curious what you think the longer term trend as a percentage of sales now that you have Perkin under your belt is 9% a realistic number going forward with some lumpiness based on projects. And then in the future I am hearing a lot about projects that I didn't even know you were working on. Maybe some indication of some of the broader more important products you have in development that could be years out to able to talk about that might be helpful in understanding the R&D spent?

I'm not sure we're going to go very far a long in terms talking about our longer-term projects but let me talk about the percent of spending. I think that is an important topic. So we expect our R&D spending to be 8% to 9%, we are at the higher end of that range this year. I think as revenues grow, that we would continue to stay in that range, 8% to 9%. I will say that we're in the midst of our planning process for next year. So when we give guidance for next year, we'll have a little bit better color around that. So that I can say more definitely, what it will be for 2018. I do still think that the long-term is in that 8% to 9% range.

Just to give more color what goes into our R&D, there's two major cost items, which is labor FTEs and secondly materials. Labor is generally constant throughout the year and we predict that and forecast that. Material can be is a part that can be lumpy depending upon how much we consume any particular quarter is we're trying to test and accelerate shipments of prototype et cetera to our customers. So that's where you might see some quarter-over-quarter wearability in when we give you color about R&D. And in the terms, how we develop products, most of our dollars go into building out platforms for our product and technologies. And then as we acquire OEMs and talk to OEMs, there some small portion that incremental amount is spent on tailoring of towards the OEM and that's the part that depends on the OEMs timeframe and can draw out but usually smaller portion of our platform expenses.

One thing I might add though is, what is changed a bit over the last few years is we historically have been an X-ray tube and a detector company. That's the value where we spent our development dollars. But now we've added the acquisitions over the last few years. Software capabilities and connected controls capabilities in terms of other accessories components and that means that we know are spending also timeline providing more of the integrated solutions where we can make sure these things are optimized, we're together. So that's a little bit of difference for us then in terms of where we have expanded into and that's a benefit for our customer by the way because we can help them by getting in terms of giving them new product to market quicker as well as more well efficiently optimize in terms of image quality and image system performance by having these products or components working together there.

The next question comes from Oscar Anderson with Bodon Home Capital.

Three questions for me. The first one is on the visibility you have on the revenues in Q4. And then the second one on the gross margin guidance for the 38% to 40% in the long-term. Does that include Perkin, so do you think the PerkinElmer business will get after that 38% to 40% range as well. And then the third question is on NIM, Perkin element rate seems to be 16% in Q3 had for two months, like how sustainable is that?

Can you repeat that last part?

The perkin element OpEx, so the SG&A and R&D to revenues what 16% in the quarter is that sustainable?

Yes, I think -- I'll work from way from the last of the first I think it so the OpEx, yes I think that I have a little bit cautious because it's only two months of indication but as I look at forecast for Q4 as we work on the 2018 planning. I don't see that being significantly different. I think they're R&D expenses a little higher as a percentage of revenues than what we have it's a near around 10%. But offsetting that is SG&A is significantly lower. So I think, that's a pretty good indication of where it's going. The gross margin longer term of 38% to 40% does include PerkinElmer and so this is where the cost energies are very important for us going forward that's one of the factors that help us to get to that higher end of that range. So that's going to continue and I think that's a good way to look at it still 38% to 40% as a combined group. And then you had a question about revenue on Q4 maybe give me a little bit more color what you're looking for.

The visibility on the revenue growth, because it needs a bit more ramp up, so in Q3 to what's bit lower-than-expected like how much kind of visibility do you have that you will get back what you lost in Q3?

I'm just can walk, as we go into quarter, we have pretty good visibility because of forecast from our customers as to what they are planning to manufacture. So there is not a while wearability I there would the exception of a few things, we'll have some drop in order during the quarter. And we will have some portion of aftermarket business that happens during the quarter and we have certain segment that just are more short-term focused where they -- the customers or the OEMs are not necessarily doing as good at long-term planning as some others are. But generally speaking, I say we have very good visibility to the quarter and I am a lot of confidence in what we have given as the guidance because otherwise you wouldn't be doing it. That 23% to 26% obviously includes the significant uptick just because of the addition of the PerkinElmer business.

Our next question comes from Lawrence Solow with CJS Securities.

Few follow-ups. On that last question. You don't guide quarterly or you didn't guide revenue for Q3. But I guess, turn the call back three months, I ask you question for Q3. Would you have had better visibility on what this number was and you may haven't just share with us at that point or it looks like missed this quarter from an area where you didn't have a lot of visibility on? Or at least the majority of them is.

Well we gave guidance for the full year and you kind of working way backwards because you know what the first half of the year has been.

So we have a second half guidance essentially.

Exactly. So think that's the best way to look at it, it is a still from that matter, we're in the last quarter of the year, so I think, that's why you end up with one quarter where the guidance.

But my question is, they just sort, I'm just trying to assess the visibility question -- were you surprised by this shortfall in this quarter or not so much?

So we knew for second half of the year that we had a tough comp. That we are comparing with the prior year with second half of '16. They has significant gross from the year prior that. So we knew that to begin with so I don't think that necessarily this is all that much of a spike because we still are looking at things the second half. As a real question I think what you're asking, is there some slippage from Q3 to Q4. A little bit but not material. I think things went fairly well as expected for the quarter.

That's fair enough, so this is not surprise to some but again, if we add back to Q4 numbers, if we believe that your visibility is fairly good and you come close to Q4 than I think that the Q3 Miss Looks a lot less than it really -- than it's more of a timing thing?

I'll just reiterate again, we looked at it for the second half of the year or for the full year actually from that perspective.

Yes, Larry we always are keep to attend because of summer and holidays at Europe, it tends to start some level of things that move around that was this year was no different.

I've got a few question. China that the $70 million new contract, does this all incremental, I know you guys had some contributions from China, as years passed or where you looking for a step up. Is this part of that step up?

No, Larry this is part of what we had forecasted and anticipated, we've got expectations of revenue growth in China and our business in China growing. This $70 million to $80 million contract was an affirmation we're on the right track and we are getting traction and locking those down. And we hope that more of these, that we can announce every year.

I realize, it's part of your outlook but it's still incremental, it's not like, it's just replacing other contracts, there is something like that?

It's a new agreement, that's true, but it was already built into our plan, it was no leaf, this is part of our China strategy.

On the gross margin. Just to clarify. The 36% Perkin was that Perkin on adjusted basis? So the 38 total number, I assume that includes Perkin. The 36 by itself is that an adjusted Perkin or a, it's before adjustments?

Guess. It's an adjusted Perkin and that does excludes the amortization of intangibles at one time, purchase accounting charges.

You guys -- i know you gave 38% to 40% range, do you think we're more closer to the lower end of the next you know before you get of outside of synergies, I feel like that 38% to 40% includes strategies?

Yes. Larry we're talking about long-term and I'm going to stay in that level of a range. I'm not sure I can give longer-term if it's 38% or whether it's 40%. And getting a little more color on it, when we do the patterns times for 2018.

Operating margin, I know you guys, you are not going to hit the 16%, this year, this quarter you didn't because it looks like there's an operation sales declines but how do you feel about that 16% as a floor and growing from there?

The year-to-date, I am not sure I know the year-to-date operating margin. I would say around somewhere around 16% or somewhere. And I would expect -- probably a little bit lower than 16% year-to-date. But I see us getting in that kind of range by the year-to-date, from Q4, it's going to help us. I mean this is, when you have higher revenues, I mean you're just absorbing your operating expenses and you are absorbing your even some of your manufacturing overhead costs -- those are -- so when you have larger revenue quarters, you end up with better operating margins.

And then just on one more specific question. A little bit more gentle one. Just on the -- I guess in terms of quality of earnings -- if you are non-GAAP numbers, I would just piece of advice you probably should take out the currency gain and on the gain on the minority interest, because that's really 1x-ish. So I would actually say your EPS will run on a non-GAAP basis or more like, $0.36, north of $0.44, I just want to know there was no tax rate difference on that gain that you had which should be $0.36 cents.

There is no tax adjustment associated with that, we define a policy internally that we're following about what items are included in the adjustments and we're following it.

And so you did call it out so I'm not being critical, I'm just we make it adjustment ourselves so that's fine, and then the tax rate at 32 little bit lower than is that just an average in the quarter or long-term views still sort of in that 32,35 range.

Tax rates are going to bounce around but so this is as you go through a year, you ended up throwing up things on your tax rates based on what you now today and you actually do a little bit of retroactive adjustment. Which impacts our current quarter look. I think it's better to look at the tax rate on year-to-date basis.

And just last question. Getting to some bunch of inquiries about the transition or what's remaining of the transition from analog to digital. We initially saw that most have already been done or at least at the high-end and some low-end outside the U.S. Then there was some thoughts have conversion now it seems like maybe that what was converted or hasn't been diverted at the low end of the market which won't help too much. If you could clarify that and then part of be of that question is, sort of CR, which is I guess transition in between analog and digital and that conversion from CR to digital, is that almost complete and has that helped you in the last few years, towards that might not help you anymore than might be a drop off?

Let me get down with that. The conversion is still somewhere around 50% of the way there. A few -- I'd say -- actually let me take it back, if there is buy by type of product lines, so if you say in the U.S., just around 50% or less than that are full digital. Now globally, for that number is much smaller about 20%. So there is still, and this is based on the calculation there's an install base of about 500,000 units to 600,000 units that need to converted, so in terms of what's remaining, there's still a substantial chunk of systems that are not digital. And then in terms of modalities that are still converting. Radiographic is accelerating and there is the largest volume of conversion is happening in the radiographies pace and that's still moving very rapidly and that is mostly the new systems that are being sold, they are increasingly going digital. First in the U.S. because in the U.S. you have reimbursement cuts by if you're using film in the U.S. there's 20% reduction by the end of 2017, if you are still using CR then it will be cut by 7% in 2018 and then additional 3% by 2023. So you can expect that CR-based systems will get phased out in the U.S. over the next five years and it's taking that progress in that direction. Globally, that movement is much, much slower. There's still a quite a bit of CR systems and then image intensified that goes with all the other surgical systems, they are still very high percentage of that being still shift as new systems that are analog. so our estimate that this things is going to have a 10 year run rate to get their globally, we still good about that. We're seeing that, we are seeing increased volume on the radio graphic side and of course, you know the volume unit growth doesn't keep up with the revenue growth because price erosion there. But we're seeing the unit volume growth that is giving us the confidence of the analog-to-digital conversion is moving forward.

In the radiographics is that more of still x-rays though or is that the lower end or is that both?

The both high and X-ray, which is still the fill short images high-end and low-end both converting to digital.

Ladies and gentlemen we've reached the end of our Q&A session. I would now like turn the floor back over to Howard Goldman for closing comments.

Thank you for your questions and participating in our earnings conference call. A replay of this quarterly teleconference will be available from August 3 through August 17 and could be accessed at company's website or by calling 877-660-6853 from any location in the U.S., or 201-612-7415 from non-U.S. locations. You will need pass code for this. It's 13666698. Thank you, and goodbye.

Thank you, ladies and gentlemen. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.