Greetings and welcome to Varex Imaging Corporation’s Fourth Quarter and Fiscal Year 2018 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to Howard Goldman, Director of Investor and Public Relations. Thank you. You may begin.

Good afternoon and welcome to Varex Imaging Corporation’s earnings conference call for the fourth quarter and fiscal year 2018. With me today are Sunny Sanyal, our President and CEO; and Clarence Verhoef, our CFO. To simplify our discussion, unless otherwise stated, all references to the quarter are fiscal quarters. Quarterly comparisons are for the fourth quarter of fiscal year 2018 versus the fourth quarter of fiscal year 2017, unless stated otherwise. Annual comparisons are for fiscal year 2018 versus fiscal year 2017 unless stated otherwise. On today’s call we will discuss certain non-GAAP financial measures. These adjusted measures are not presented in accordance with, nor are they a substitute for, GAAP financial measures. We provided a reconciliation of each adjusted financial measure to the most directly comparable GAAP financial measure in our earnings press release, which is posted on our website. Please be advised that during this call we will be making forward-looking which are predictions or projections about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties that could cause actual results to differ materially from those anticipated. Additional information concerning factors that could cause actual results to materially differ is contained in our SEC filings, including Item 1A a risk factors of our annual report on Form 10-K for fiscal year 2017 and subsequent quarterly reports on Form 10-Q. The information in this discussion speaks as of today’s date and we assume no obligation to update or revise the forward-looking statements in this discussion. And now, I’ll turn the call over to Sunny.

Thank you, Howard, and good afternoon, everyone. We ended our second year as a public company with double-digit top line growth. Revenues for fiscal year 2018 increased 11% from the prior year to $773 million. Medical segment revenues increased 8% and Industrial segment revenues increased 21%. We benefited from a full-year contribution of detector revenues from the acquired imaging business, we saw an increase in CT tube revenues including those for OEM customers in China. We also saw continued growth in our connect and control products and software solutions. In addition, revenues grew for mammography and cardiac modalities, as well as, industrial and security applications. Offsetting these improvements was the decline in 3D dental imaging detectors compared to the prior year. While our revenues for the fourth quarter decreased from record revenues in the prior year quarter, revenues increased 7% sequentially from the third quarter, driven by growth in the CT, mammography and industrial markets. Tariff increases impacted our business in the fourth quarter through direct payments made in the U.S. and China and price concessions given to customers importing our products into China. For the near term, we expect tariffs to continue to affect our revenues. While our customers are often responsible for paying import duties on our products shipped into to China, many Chinese customers have requested price concessions to partially offset their increased expense. Based on this, our projected revenues for fiscal year 2019 includes $10 million to $15 million of impact from currently enacted tariffs. Said another way, the higher tariffs will negate a good amount of the incremental revenues we expect from CT tubes in China in fiscal year 2019. So, let me talk about some of our mitigation efforts with respect to tariffs. We have been talking to our legislators and the Office of…

Thanks, and hello everyone. I’m going to focus the discussion on Q4 results while the fiscal year financials can be found in our press release. I’ll follow that up with the details of our FY 2019 guidance. The highlights of Q4 were the strong top line performance that exceeded our expectations combined with good expense control. These were more than offset by gross margin challenges due to tariffs and unfavorable manufacturing variances at our Santa Clara glass fab facility. The variances were significantly higher than expected and we anticipate similar difficulties in the first quarter of fiscal year 2019. You will recall that last quarter we announced the shutdown of the Santa Clara fab operations, which is on track for the end of the calendar year. Tariffs are now having a direct impact on our business. In Q4, our gross margin was reduced by about $2 million due to tariffs with roughly half due to price concessions to Chinese customers importing our products and the other half due to direct payments of supply chain related tariffs in the U.S. and China. As we look ahead to fiscal year 2019 we expect to incur about two to three points of negative impact to gross margin due to currently enacted tariffs including price concessions in the range of $10 million to $15 million. Our fourth quarter revenues were down 5% compared to a very strong quarter a year ago, which had all-time high levels of detector sales for the dental and oncology markets. Sequentially, we saw revenues increased 7% from the third quarter with good performance in the Medical segment. For the fourth quarter, our gross margin was 29% compared to 36% in the prior year quarter. The adjusted gross margin was 33% compared to 38% a year ago. The declines in…

Thank you, Clarence. Before we get into Q&A, I'd like to take a few minutes to outline some longer term thoughts for Varex. Looking beyond the current trade war and tariff situation with China, we continue to see large and healthy end-user markets for both our Medical and Industrial segments. We feel secure about our position as a leading innovator in X-ray components and believe our investments in R&D will allow us to both develop new technologies that are ahead of the curve and bring new products to market that will result in widening of the gap between us and our competitors. In the Medical segment, the conversion to digital is driving demand, not only for our detectors but also for our high-performance X-ray tubes that can enable more advanced 2D and 3D imaging. Mammography, surgery and dental imaging have continued to lead the field with new and advanced imaging applications and we believe these areas will continue to be strong over the next three years. We see ourselves well positioned in these areas of growth. In addition to developing components to support emerging market product roadmaps of our global OEM customers, our strategy is to build strong R&D relationships with the local OEMs. We're very pleased with our position in China with local OEMs and having our components engineered into their CT systems. While some of them may experience typical delays with product development or regulatory approvals, we're still confident of our prospects in China. As mentioned earlier, China's National Health Commission announced the planned installation of several thousand CT scanners over the next two years, which is in line with our expectations of the adoption of CTs in China. Our local Chinese OEM customers believe that they are well positioned to win, and this adds another data point…

Thank you. [Operator Instructions] Our first question is from Anthony Petrone with Jefferies. Please proceed with your question.

Thanks, and good afternoon. Maybe to start just with the guidance ranges and sort of the implied impacts within there. The ranges are wide here, top line down 2.5% to up slightly for the year and then similarly on the bottom line down 4%-ish to up 19%. So in particular on the top end of those ranges sort of what needs to, sort of break in the company’s favor in order to hit those top line forecasts or top of in-range forecasts, and then I’ll have a couple of follow-ups? Thank you.\

Hey, Anthony. So I guess – I mean, I kind of did a little bit of a walk through. The first question, I think, first part of your question is about the broadness of the range and maybe kind of little address that first and then I’ll kind of touch on the kind of the drivers I guess for the high end of it. The first thing is just because of the tariffs already, I would say that’s the biggest driver where there’s still a fair amount of uncertainty about where is this going to end up. Okay. So we made some assumptions with the current product and the current tariff rates that are in place as to what that is. But we’re still – you’re still a little bit at the mercy of how much that mix of products is from the customers themselves in terms of how much that number will change. So it does mean that it’s a little bit different than usual in terms of the amount of variation just relative to that. Then the other side of it is we hear – you hear us talk a lot about what’s going on with China and it’s going to be a lot about the timing of the ramp up of activities in China. And this is – we see this whether it’s with the – where the different OEMs are in their regulatory cycle or where they are in terms of introduction into the market and the volumes that are going on there. We do see sizable increase there in terms of the expectations for the number of CT tubes that we will ship in this next year. And so I think that’s probably the biggest other factor that goes into the broadening of the range.

Very helpful. Maybe just the follow ups would be just the comments on tariffs in particular. So just to review, there was a lot of moving parts on U.S. tariffs, retaliatory tariffs, which particular schedule of tariffs is baked into the $10 million to $15 million? And then one step further would be, is that exclusively China OEM related tariffs or is this more broad to include multinationals? And then I’ll have one last follow-up on the earnings guidance. Thank you.

Yes. Hey, Anthony, this is Sunny. Let me get it started and then I’ll ask Clarence to fill in on more specifics to the numbers. First of all in each – the first – if you recall the first wave of tariffs that were introduced didn’t impact us in any significant way. And then the subsequent waves introduced additional codes, the tariff codes that then were impact to us. So this is on the buying side, the U.S. imposed tariffs on parts and products that were imported from China. Correspondingly then there were retaliatory tariffs that China put in place, then that impacted our – the sales of our products into China, which then were exposed to those tariffs. So tariffs impacts us in three ways. First and foremost, on the buying side. When we buy materials, parts, pieces from China, whether it’s us directly or our second tier suppliers that those numbers we know very well. We can quantify them fairly accurately based on our current year’s volumes. The second is, products that we ship directly to our Chinese customers. We also have fairly good handle on those. We understand volumes and numbers within the range of our forecast and guidance. And on those the uncertainty is that we’re negotiating one-on-one with every single one of those customers on splitting the sort of the difference so to say, right. But I’d say it’s within the zone of I’d say you can bracket it in terms of upside-downside there and we’ve done that. The third part which brings bigger uncertainty, which is really not – hasn’t been broad enough yet, but we’re being cautious about this is to the extent that any of our other customers that bring products into China that we ship to them, to extend that those – they start to be impacted by tariffs. And I know we will – if they come to us they’ll probably want to negotiate with us on sharing some of those costs and that is less defined and not well quantified and those are hypothetical so to say. So that’s the three ways in tariffs are impacting us.

Great. Helpful. And then just – yes.

Anthony, maybe just one other clarification just because we’re talking about an impact of two to three points on the gross margin line. And in the fourth quarter, we didn’t see the last round of changes with tariffs really take effect till middle of the quarter and so we did have some volume of activity that went on with that was not subject to tariffs in the first half of the quarter and then the second half of the quarter had more of an uptick. So overall, we saw about a $2 million impact roughly equally split between price concessions and fees that we paid, but we do anticipate that being higher as you get a normal run rate going forward, in terms of volume of activity.

Great. And then last one is just in terms of the cost cutting efforts. I know part of this is middle of the year and its related to Santa Clara. But how much is baked in just for general cost containment efforts out of Santa Clara and I’ll hop back in queue? Thanks.

Yeah, I guess I’d define it in multiple ways, right. So the parts that impact the gross margin line in particular is heavily weighted to the activity that’s going on with the closing of the Santa Clara fab operations. And so we get a sizable impact out of that somewhere in the range of $7 million to $9 million on an annual run rate basis that we’re going to get. Most of that doesn’t kick until at least the second quarter and then there is the other side – then there’s the negotiations that we’ve done with suppliers and the supply chain side to get cost reduction that also has a favorable on the gross margin line. In addition to that we’ve looked at some of our expenses and that’s where I went through reducing R&D and reducing SG&A as a percentage of revenue, that’s not – I mean, obviously, because the top line number is not changing that much, this is not about leverage. This is about actual cost reduction actions that have happened. And so, we’re well down that path already. And so those percentage changes 0.5 point to 0.75 point reductions in each of those categories is driven by those cost reduction actions.

Thanks again.

Sure.

Our next question is from Larry Solow with CJS Securities. Please proceed with your question.

Great, thank you. Just a couple of follow-up some. So on the tariff specifically, so it sounds like, if we do the math, just on the margin impact you’re saying $10 million to $15 million on the revenue side, but – and the total impact, I guess it’s about $25 million. Is that – based on your sort of 2% to 3%, is that a fair estimate?

Yes, Larry, I mean, I think you can just do the math, two to three points around the revenue and you get into that range, maybe not quite as high as $25 million, but, yes, you’re in that kind of range.

So essentially, it’s almost – you’re sort of assuming almost evenly split like it was in Q4 between – it did impact for you on your materials buying stuff and then the price concessions. Now the third point, the uncertainty, how does that layer into your guidance? Is that just sort of tweaking your overall sales guidance? Could you – if we sort of remove the tariff impact, you’re only growing sort of flat to up 2% which would a year ago, we would probably said coming into this year, we expect more growth than that.

Let me – can I go back to just for a second [indiscernible].

Yes, I am sorry. Please go ahead.

Because the split, whether it’s price concession or whether it’s expense that we incur is a lot based on how the transaction is done. So if we are at the importer of record as such when we’re importing certain products into China, then we’re paying directly or when we’re buying parts from China, then those are the items that we are paying directly. While a lot of times, our customers are the importer of record and that’s why we end up with a higher weighting to the revenue side of it or the price concessions side, but there is also more volatility in that because those are negotiated customer by customer in terms of how much the split is between us and how much they’re paying themselves or absorbing themselves. So I think that’s kind of a key distinction that happens in this process. And then in terms of the, the variability I guess in the number maybe a little bit is, if you just kind of look back at our year that we just finished we had a fair amount of variation in our quarterly numbers as well. I mean we had a very strong Q4 here at $205 million and our expectation was not as high as that. So we’ve got that kind of variation just happens in our business inherently. So, I want to make sure that we have that accounted for when we’re talking about the guidance levels.

Okay. And then just I guess – and then the follow-up to that was sort of the growth again I realize this is – it’s not an exact science, but – so the impact from tariffs on the revenue side may be greater than $10 million to $15 million. But if we simply just take that on the surface, your sales growth would sort of be – that you’re sort of guiding to sort of flat to plus 2%, which I think if you told me that at the beginning of last year that your guidance for this year would be that I think we would be disappointed, especially coming off of a down year, or a flat organic year which was partially impacted by timing in Japan. So taking those – all those factors into account what, can you sort of give me a little more color on that?

Hey, Larry, this is Sunny. The cautiousness on the top line for us is that even though we see good progress and continued progress made by our Chinese customers, we’re just layering in – putting in a layer of caution on that thing. Let’s just be – there’s always some delay sometimes possible for R&D projects and FDA approvals. We’re just taking a cautious stance here.

Okay, that’s fair enough. I don’t really want to look back on Q4 because I think going forward is more important. But it sounds like Q4, obviously you said you – on the medical side, you actually did somewhat better than you thought. You thought you are going to flat sequentially and you – I think you said up around 7% or something, maybe that was 12%, but you were certainly upper than that [ph]. Was that – you said – you mentioned CT was that sort of some of the timing in Japan that came back? And then the flipside of that was industrial, although a little bit on – were the small numbers, but you were down somewhat more on a percentage basis than we thought.

That’s fair. I mean I would say that we had a variety of markets that actually did well. I mean, for as much as we are up, we are up $14 million around Q3. So that’s not insignificant and it was in CT. So good – and that’s a big part of our business if you think about it. And so that’s good to see some good performance in CT or continued good performance in CT. A little bit of variation quarter-to-quarter, but I think all in all, the year was a good year for CT. Mammography, we touched on a couple of different times as an area that has performed well for us. We had a couple other niche spaces just from comparison Q3 to Q4 such as oncology and the veterinary markets that had upticks as well. So I mean it’s – it was a pretty across the board kind of good results on the medical side. And, yes, you’re right Industrial was a little bit on the light side. I mean not – yeah, I mean that’s more around just a little bit of the timing of some shipments on the cargo side I would say than anything at all.

Okay. I know you don’t guide, you don’t break out by segment. But Industrial has been sort of organic base has been growing mid single digits do you expect that in 2019?

Yeah, without getting very specific, I think the industrial space is probably still going to grow faster than the medical space. I mean, just somewhat of it because of the, the law of small numbers, it’s a little easier to do from that perspective. But I mean I think there’s a lot of good stuff going on in the industrial side. Sunny kind of talked through some of those things that are going on specifically around security as well as non-destructive testing kinds of applications.

And then the impact on tariffs I imagine is much less or minimal on the industrial piece for you guys, right?

Well, I wouldn’t minimize it totally.

At least on the revenue side, maybe perhaps not on the cost side.

Yes, we still have – we do sell detectors that go into China. And so that’s – they get tariffs charged on those as well. But we have alternative sources in terms of where they come from. So a lot of those may not ship out of the U.S. but rather ship out of Europe. So that’s what’s helped us a fair amount.

And do you guys find yourselves at least in China, it’s only really you I think one primary competitor that’s selling into China that’s selling to other OEMs at least. Being there they have the European base that they are not being impacted as much or not at all? So there is a competitive disadvantage for you?

I think that’s one of the worries that we have with tariffs in general is, is that our competitors are not U.S. based. And so that’s where we look at our global footprint and we say, okay, where should we be doing some of our manufacturing for some of those, even if it’s the final assembly and test steps or some of the kind of the latter parts of the operations, if those are done in a different location we can probably avoid a fair amount of the tariffs and we’re heading down that path.

So you – and you mentioned that you’re going opt out of facilities. So do you think that – does that actually enable you to sort of avoid a lot of tariffs if you are only doing the final assembly in that or does the Chinese government sort of say that that’s a little bit – that’s not maybe cheating them little bit if you will?

We’re not going to, we’re not out to cheat anybody.

Right. That’s the wrong words. But you know what I’m saying maybe just sort of get that loop hole, getting around then maybe that won’t – then maybe that won’t fly.

There are different tariff rates for different product harmonization codes. Okay. So what are the import classification is determines what the rate is, so there definitely and we look at that and understand that and it depends on what that part is that we’re importing as to what the tariff is and so we’ll take advantage of that. No doubt. Then in addition, obviously where it’s sourced from, so if a product is shipping from Germany, there is no tariff at all, or a very small tariff compared to a product that is shipping from the U.S.

Right, okay. Go ahead, I’m sorry.

No, Larry, there are specific rules around what you have to do in different countries, in order to get that manufactured in XYZ-country label and that’s what we’re tracking with and saying, how can we leverage our presence in Germany and leverage our presence in China to take – to do the right thing.

Right, okay. And then just last question. I think, myself, and I think some other investors, obviously it’s been this year is a little bit rocky and I think since came on your IPO, I think you’ve had some pluses and some minuses. I think one concern that people had had been sort of the guidance and some of it’s out of your control, but I think one line item on the P&L that I think upsets some people is that or just has been a little frustrating is on the SG&A side where we would think you have a little more control and a little bit more visibility on that. And you haven’t really been able to lower expenses too much. I realize it is so because it’s a percent of revenue, but it does seem like just on absolute basis they have been a lot higher than we thought. Do you feel like you’re – you talked about that you’ve sort of done a bottoms-up and hopefully get better control of that going forward, do you feel that’s the case?

I mean I feel like we have done the right things in terms of taking some actions to actually reduce those expenses and you’re going to see the impact of that in FY2019.

Okay, great. Thanks guys. Appreciate it.

Our next question is from John Koller with Oppenheimer & Co. Please proceed with your question.

Good afternoon, gentlemen. How are you doing?

Good. Hi John.

Hi, John.

Hi. A quick question, I may have missed it, did you give a CapEx number for fiscal year 2019?

I think I did, it was $20 million.

$20 million. Okay, great.

Yes.

Thanks for that. If I look at the $20 million and I look at what you’re going to generate in cash flow or expect to generate in cash flow, I’m curious if you would comment on where you see the bulk of that cash going. If you’re looking for debt repayment or maybe another use of that cash?

I would say that it starts to fundamentally with debt repayment. That’s the default for us and we did a good job of that and in FY 2018, we reduced it by $96 million and some of that was we actually reduced our cash balances as well. I mean – so we got, we had some of the cash was trapped offshore a little bit. So once we got that back to the U.S., we were able to reduce the debt. That isn’t to say that you know acquisitions aren’t still on our radar. We did the acquisition of VMI in this last quarter, pretty small, $5 million acquisition about one times revenue kind of number. And that’s a – those are the kinds of things where they are good tuck-ins of a technology that – and access to a market that we haven’t had so much before and so there is a lot of value in those kinds of acquisitions.

Okay, great. And does the CapEx budget take into account any plans that you might have to augment non-U.S. manufacturing?

Certainly. Yes, so we have in our plan certain amounts of expansion in certain locations. It’s not huge. And it’s basically taken out of our current run rate of CapEx. It isn’t something that it’s a large incremental.

Okay. I mean, specifically as it relates to tariffs. I guess I should have added.

Well, I mean – yeah, I mean, so if there is – we’ve got a global plan in terms of what our footprint is and where we want to, where we want to be doing things and we’re executing to that plan. Some of that is expansion in some locations. We have a sizable footprint in the Philippines, for example. We want to have more activities happening there and at the same time we look at what we’re doing in China. And there is a few equipment needs that we need to do. I think we have enough factory space or physical space there, but we want to actually finish filling it out with some equipment.

Okay. And then regarding R&D, really quick if I could, is – can you provide any additional qualifications, as far as, timeline goes whether we’re mostly front-end loaded or if these are still longer-term projects that you’re working on before you see a boost to the revenue line? Thanks.

Well, I guess, we always have a series of projects that are under way in various stages, okay. So, they’re all kind of coming out with products that come to market at different stages and they are in different stages of that release cycle. So yes, I mean certainly we’re now seeing the CT products that are specifically for the Chinese OEMs. That’s all coming to market now and so we start to see an uptick in the revenues that come from that for example. There are other products like that or other projects like that that have longer cycles in that including a lot of activities that are support of our existing customer base. It isn’t all about always necessarily a new customer as much as it is an existing customer, either expanding their portfolio or going through a refresh cycle of their products, of their imaging systems.

Great, thanks.

All right. See you, John.

[Operator Instructions] Our next question is from Anthony Petrone with Jefferies. Please proceed.

Just a quick follow-up on the update on where the China OEM order books sits heading into fiscal 2019. I think on our last notes we had that total order book was something around 170. I think a portion of it had slipped into 2019. So maybe just an update on the totality of the order book and what you expect to realize in 2019?

So I think when we talked about our orders, we had said there would be back-end loaded because the first year of that order book, bookings of those five customer contracts that we had, we were anticipating that most of that would go towards supporting their prototyping, FDA, regulatory submissions and testing needs and some limited volume shipments. And what we saw was in Q4 we saw the uptick and there is a good pickup in tube volumes and then going into next year, as I said we are going expect – we’re expecting to do double of what we did in 2018. So directly to answer your question that I’d say that the business has moved to the right because of a few delays, but it is still – it still continues to be back-end loaded. So what were baked into 2019 is our best estimate of – it’s not the one-third, or a third or third like we had said, it will be more like much smaller than a third.

Okay. That’s helpful.

We have reached the end of our question-and-answer session. I would like to turn the call back to Howard Goldman for closing remarks.

Thank you for your questions and participating in our earnings conference call for the fourth quarter and fiscal year 2018. A replay of this quarterly call will be available from today through November 22 and can be accessed at the Company’s website or by calling 1877-660-6853 from anywhere in the U.S., or 1-201-612-7415 from non-U.S. locations. The replay has a access code which is 13684105. Thank you and goodbye.

Thank you. This concludes today’s conference. You may disconnect your lines at this time and thank you for your participation.