Greetings and welcome to the Varex Imaging Corporation First Quarter Fiscal Year 2020 Conference 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 will now turn the conference over to your host, Mr. Howard Goldman, Director of Investor Relations. You may begin. Please go ahead, sir.

Good afternoon and welcome to our earnings conference call for the first quarter and fiscal year 2020. 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 quarter are comparisons are for the first quarter of fiscal 2020 versus first quarter of fiscal 2019. 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. Outlook for our net earnings per diluted share is provided on an adjusted basis only. This adjusted financial measure is forward-looking and we are unable to provide a meaningful or accurate compilation of reconciling items to guidance for GAAP net earnings per diluted share due to the uncertainty of the amount and timing of the unusual items. Please be advised that during this call we will be making forward-looking statements, 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 from those anticipated is contained in our SEC filings, including Item 1A Risk Factors of our quarterly reports on Form 10-Q and our annual report on Form 10-K. 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. Good afternoon and welcome. We started off this fiscal year with strong top line performance in the first quarter. However, our profitability was below expectations due to a number of different factors that Clarence and I will review with you. Revenues in the first quarter were up 8% to $200 million from $186 million in the same quarter a year ago. Direct conversion contributed $5 million in the quarter. On a segment basis medical revenues increased 8% and industrial revenues increased 6%. Our revenue growth was driven by higher global sales of CT tubes and products for oncology, dental and airport baggage screening applications, partially offsetting these gains were lower sales already graphic digital detectors and mammography products. Growth in our industrial segment in the first quarter was once again led by strong demand for our industrial CT tubes for airport baggage screening applications. To give you some color according to third party research, the global market for these airport screening systems is projected to grow at the rate of more than 5% compounded annually over the next five years and reached $4.3 billion by 2023. Stringent security regulations and the need for improved throughput, has been driving the demand for CT systems for both checked and carryon baggage screening. Over the coming years, we expect that most airports will replace older systems with more sophisticated next generation CT systems that offer 3D imaging and automated threat detection capabilities. In nondestructive testing and inspection, we continue to ship linear accelerators for imaging applications in the aerospace, defense and manufacturing verticals. During the quarter, we also opened a new office in the Houston area to be closer to and better serve customers in the oil and gas vertical. We have several new products for this vertical moving through…

Thanks, Sunny, and hello everyone. As we follow-up on Sunny's comments about the Santa Clara closure, as we get closer to completion of this project, we now have a better view on timing of its financial impact. Previously, we indicated that the net annual benefit from the closure would be in the range of $21 million to $27 million, beginning in the second quarter of fiscal year 2021. We've already received some of that benefit by closing the glass fab portion of the facility in the first half of fiscal year 2019. By now pulling in the closure date for the rest of the facility, we expect to receive a full year of benefit in fiscal year 2021. Last quarter, we indicated that there would be $0.05 to $0.07 of EPS impact in fiscal year 2020 for the overlapping costs of the transition from Santa Clara to Salt Lake City. The pulling of the closure date allows us to offset these overlapping costs within this fiscal year and help to maintain our gross margin expectations for the full year. Now turning to the quarter, we had good revenue performance while both gross and operating margins were weighed down by some onetime events. In particular, we had an additional week in the first quarter. Fiscal year 2020 is a 53-week year for Varex with the first quarter being 14 weeks instead of 13. This impacted a number of items throughout the P&L in the first quarter. The good news is that an added week delivered some additional revenues; however, the extra week contained a number of holidays which had a negative impact on productivity, while we also have higher operating expenses due to the additional week. For the first quarter, revenues were $200 million compared to $186 million in the prior…

So before we move on to Q&A, this is Sunny Sanyal, I just want to take a moment to acknowledge that tremendous contributions that Clarence has made to the Company. Clarence has been an integral part of our company for many, many years and then inspirational leader through the spinoff from Varian three years ago. During his time as a finance leader for Varian and later Varex, the imaging components business grew revenues from under $100 million over $780 million, and with his help and guidance, we established the global finance team and the corporate infrastructure that will lead us into the future. His in depth knowledge of the industry and our operations have been a tremendous asset, and we've been very fortunate to have Clarence in our management team. With that, let's open up the call for your questions.

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Your first question comes from line of Anthony Petrone with Jefferies. Please proceed with your question.

Thanks and Clarence congratulations and best of luck to you in the future. Hope to cross paths again, as time goes on. Maybe just to stay on the topic of CEO just to address just transition, expectation for timing on transition and just what the approach is going to be there? And then I'll have few follow-ups. Thanks.

Yes, Anthony. So Clarence, as we said, has expressed his intent to retire. So with that, we are just beginning the process and we didn't really start until -- now, we will get going. We expect to do this expeditiously, but Clarence will stay on for a significant portion of the year and he'll assist in transition through that.

And then, maybe just to shift to the numbers for the quarter and just go into adjusted operating margin and guidance and just the bridge. So, I understand that some of the costs or non-recurring and allocated to the first quarter, but maybe just as you look out over the next three quarters. Where's the comfort level in sort of getting back the $0.07 deficit that we've seen here in the first quarter? And specifically, what are the drivers there? Is it is it mix? Is it the expectation for order flow from whether it be China OEMs or newly signed customers, et cetera? So just a little bit of help in bridging from the first quarter numbers to the guidance for the full year?

Sure. So, I'd say this, I mean, I think you've touched on a couple things. First of all, that you have some one-time events in the quarter, but that also maybe the margin rates, both operating profit and gross margins being a little lower level than would be for the full year. The key item is actually going to be all around the Santa Clara closure by pulling that in by a quarter, I think that makes a significant benefit. And before we had built into the numbers, the overlap costs of ramping up operations in Salt Lake City and a little bit in some other locations and with none of the benefit happening in the in the fiscal year and really fundamentally not happening till mid-2021. So, now as we pull that, we get a little bit of that benefit or some amount of that benefit in the fourth quarter already and that has a good impact for us. I would say that the other element is, as we've seen the good demand on for CT tubes going forward for the year. That helps us a little bit on the product mix side. So, I think that's going to be the other element that is going to make a bit of a difference there.

And maybe shift gears just to top line outlook and specifics on to your comments in China. So, we've seen so far this earning season, just the mix view as it relates to coronavirus. You mentioned in your prepared comments that potentially there's some higher than expected demand due to coronavirus. Just trying to get a sense of installation cycles specifically for CT machines in China? Siemens, for instance, sort of announced that, it's not necessarily orders, but timing on installations that could be impacted, so just maybe a little bit on CT installation cycles in China? Thanks. And then we'll have one last follow-up.

Yes. So, Anthony, we don't get good visibility to what it takes for our OEMs from the point where they order are to, how long it sits in their facility or how long it gets, how much the elapsed time is to install the systems. From our perspective and customer places an order, we typically shift X works, so the point where they pick up the tubes is when we consider as having shipped to them. Now that said, the reference I made to slight uptick in demand for the tubes, these are for immediate shipments. I mean the customers are standing on top of us to try to get these tubes from us ASAP, these over and above what they had ordered. So, we're doing our best to get these out to them ASAP and trying to cover as much of that in sort of with urgency. And these systems will get shipped out by our customers ASAP, out of their facilities. So, that's -- I don't know if that answers your question, but these are we expect to fulfill bulk of that extra demand in this current quarter.

Okay and last one for me. I'll get back in here. In tariffs, there was a deadline that was upcoming in December, some other capital providers specifically intuitive mentioned there was some pull forward of orders have that potential deadline, of course, it never happened. But just wondering, if there was any sort of tariffs dynamics in the quarter? Thanks again.

No, we did not see any, any change in our customers ordering patterns for any other behavior change one way or another due to the tariffs.

You next question comes from the line of Larry Solow with CJS Securities. Please proceed with your question.

Just a couple of questions. Sunny, you mentioned that you had a separate release on the Canon agreement and you actually mentioned that you've re-upped. It sounds like on greater than 50% of your medical contracts. Can you give us any feel for pricing volume changes? Are these contracts basically just rolling over at similar levels? Any color there will be great.

Yes, Larry, a couple of -- first a backgrounder on the reason for my comment about the other contracts. So, first of all, it's great to always see our largest customer Canon continued on this with decade's long relationship with us. So, we're excited about this. We're into the second month of the calendar year and I thought I'd just as a frame of reference to give you that example of how we're doing with the rest of our customers and it says a representative. The key point there for us is that these are multiyear agreements. So that means, it is our customers not only have faith in us, but also faith in stability of pricing in the market. You might recall a few years ago and we were seeing huge swings in detector pricing very few customers would agree to any kind of a multiyear pricing agreement with us. We're happy to say that we're able to get our customers to lock in with three pricing agreements. So, we're very happy about that. And then coming to your question about any color on pricing and price erosion, et cetera, nothing, there's been no real shift in pricing approach or price erosion since our previous conversations that are in other noteworthy. Tubes, pricing on tubes has continued to be consistent with historical levels. In fact, we get in some case, we wrote to hold prices. In some cases, we get some nominal adjustments for volumes. And actually, in some of the cases, its performance driven, we've started looking at performance based pricing. So, I'd say, the tubes have been fairly consistent. Detectors fees price erosion and we've said historically, we've seen price erosion in single digits and that has continued. So, there's really nothing dramatic that's worth mentioning.

Okay, just kind of follow-up on Anthony's question about the profitability of the quarter. So, obviously it was -- I know you don't guide to the quarter, but it sounds like it was certainly below your numbers on the gross line, and then operating expenses, obviously, were certainly much higher than your guide was for the full year. Is there any -- you said there was an extra quarter, an extra week and a quarter, but that also should obviously benefited revenue. So, I'm just trying to bridge the gap a little bit better and you sort of said you'll make up for it with a little bit of an earlier closure on the facility, but making up for it. But is there -- we had a lower -- in other words, was just this an aberration or you have to make up for it and then some with other quarter of lower numbers? I'm just trying to get a better grasp of that.

Let me take a shot at that first, Larry.

And Sunny, just trying to figure out why you missed, not how are you going to make it up? You've explained how you are going to try and make it up, but you haven't really explained why you miss?

Yes. So, I mean, the adding an extra week is not an insignificant impact on the operating expenses. You're right, we get a little bit of extra revenue which is what I mentioned, and the variability -- your variable costs are going to be running at the same kinds of levels as the revenue. So, that's normal. But the OpEx expenses, there's no offset to that. So there's an incremental, $4 million or $5 million, something in that kind of a range of additional operating expenses in the quarter just do the extra week and that's basically in R&D and SG&A. And then, within the gross margin, you basically have a few of those unusual or one-time kinds of events, not necessarily around all around the extra week, but it more about relative to the detector business didn't perform quite as well as we wanted it to do in the quarter. And I mentioned, customs audit where we set aside some money for that and set aside some money for warranty and slow moving inventory. Those are all factors that come into play and are the primary drivers of that. I think, there's beyond that it's kind of business as usual, I would say in terms of the rest of the moving parts in quarter.

And then just switch a gear a little bit, Sunny mentioned, you spoke to the some of the closures of the facility in China and hopefully that reopen soon, and then also the coronavirus and maybe actually get a little bit of benefit from diagnostic, some more diagnostic equipment going towards that. But net, are you -- do you think from where you stand today in your guidance is coronavirus have any effect, negative or positive? Or is it right now you're not adjusting for that?

So, it's too early to tell one way or another.

I mean just quantitatively of the question?

Yes, quantitatively unbalanced, the extra orders of tubes and detectors will be helpful. Those we hope are incremental versus pulling. Again, tough to say but since these are going to the sites that are specifically impacted by the coronavirus, you can hypothesize that these are incremental through the normal plans that any hospitals might have, but that's still TBD. In terms of on the cost side, we carry, we haven't seen any -- there hasn't been a cost impact to us. We carry inventory for our materials and purchases and the things that we depend on from China. So, for the rest of the quarter and as we get into all the way through March, we're working off of our current supply chain. So, we haven't felt an impact one way or another. Now, if the situation gets worse and beyond the current projections then I think the entire industry and globally everyone will be impacted and us, in a similar way. So, that's a wait and see situation for us.

I think, Larry, though, what this does is it introduces a little bit more uncertainty in the year. In terms of quarter-to-quarter variation just like we talked about that we already have quarterly variations just it's more of the same as what that tells me.

Just last question, any update, I mean, how directors performing? I think you sort of scaled back expectations a little bit last quarter from I think initially when you acquired it. You mentioned $5 million this quarter, but perhaps, it's a little bit of an inflated number. So, any update on how that's progressing?

So, I would say that. Okay, the $5 million is a nice number for us and you're right that we have backed off a little bit on the timing of when we expect some of their deliveries to happen to their customers. And this isn't about them being having challenges with developing product or getting product out the door, but it's more about the new applications that directors directs product photon counting is going into, take time to get to the market and get gone through the market acceptance phases and the development process by their customers. And that's been a little bit where we see their challenges being a little bit around the timing of when their customers will be ramping up their business. I mean, overall, it's still proving out to be a very strong technology that is being well received. We have a ton of traffic at the RSNA trade show around it. There was a lot of interest in the products. So, I think it's going to do very well, but it's a question a little bit about how near-term versus long-term.

Your next question comes from line of a Suraj Kalia with Oppenheimer.

So first and foremost, Clarence, it's been a pleasure dealing with you and best of luck to all the way to still be dealing for a couple of quarters I guess, but congrats nonetheless. So you guys provided a lot of commentary. And Clarence maybe you can or Sunny maybe you guys can fill in the blanks for us. The 8% uptick in your medical segment, so one was Sunny your comments about the short term demand, right. The customers wanted to fill orders ASAP for whatever reason? The second is, there was an extra selling week and that was offset by holidays. So when I take all these three. Can you normalize for us what the medical segment growth would have been year-over-year, if I remove some of these factors? And I guess what I'm trying to understand is, how sustainable is the step up in this category, particularly?

So, Suraj, I'll let Clarence chime in, but let me just clarify. The extra demand that we saw for or that we alluded to for coronavirus was not in Q1. It would be for what we would ship them now, right. So those are coming in now. So, timing wise, that didn't impact our first quarter. The extra week does have positive impact and I'll let Clarence comment to that.

I mean, it's an extra week of production for us is the key around that. Maybe if I kind of walk through a little bit of what I how I interpret the movers of the increase. Okay, so we're at 186. We ended up in at $200 million -- a 186 a year ago and $200 million now. So, we talked about direct conversion adding $5 million because that was not in the comparable period a year ago. But the extra week, I'm going to just -- I didn't put a specific numbers around it, but it's probably something in the order of magnitude of $3 million to $5 million or something like that. So, then you have just overall growth that's going on in our markets. And I think we touched on these a little bit because we've got multiple markets that went up double digits for us, as in the CT markets, the dental market, the oncology markets in particular. Those are the biggest drivers as well as in -- and we're talking about medical, but the industrial business did well in addition. So, those markets have got good strong demand going for us. It's nice to actually see that recovery going on in the dental space that we now seem to be more of an ongoing trend as such. But it's -- at end of the day, the big money for us is still in CT tubes. I would say that's the biggest factor.

You've got it. And Sunny, you guys put out this press release on renewal of the multi-year contract with Canon and there is commentary about other customers. Maybe if I can just kind of peel a layer of the onion here, is that a tiered volume arrangement? Is it on a rolling order basis? How should we think about it? Is it just 385 divided by 3? And how does it stack up relative to the comps, let's in the prior contract. Just help us contextualize. Is it just going to provide price stability, but even if I look at that, just on the three-year to three-year or whatever the prior contract was, any color there would be great? Gentlemen, thank you for taking my questions.

Yes. So, Suraj, I want to try to answer your question without just exposing competitive information in general. Our pricing agreements are based on our customers' forecasts of volume. And generally speaking, our large customers have done a pretty good job historically with their business plans. So, the 385 is an estimate based on what our customers are telling us that they'll do over these next three years. And based on that, we believe that. Based on that, we associate an average price for the different tube models. So 385 is a roll up based on that. So it's not an ongoing rolling basis. It's based on, they tell us they're going to do X number of tubes per year and we come to an agreement on the price for that. And that goes true -- that's true for other customers as well. And Okay. I hope that helps.

Thank you. Your next question comes from a line of Mark Strouse with JP Morgan. Please proceed with your question.

Yes. Thank you very much for taking our questions and Clarence, I'd like to add my congrats as well. And so Sunny, I just want to kind of follow up on a couple of questions that have already been asked, but you mentioned a couple of years ago customers not necessarily looking to lock in to pricing over a multi-year term. Really, since the spin, as far as I can recall anyway, you've been kind of targeting long-term growth in that mid-single-digit range. I'm just wondering if there's been any kind of change in that forecast now or reasons to be a bit more optimistic now that the customers seemed to be a bit more comfortable locking in. So does that give you any reason to think that number could potentially be higher?

So, on the -- there's no change in our position. We've said that the medical market is growing at 2% to 3%. Industrial market is growing at 4% to 6%. So blended, we expect our growth to approach and now, we're targeting 5% growth. And it's -- as one of the market leaders where you end up growing more or less with the market, the different -- but we expect to go do slightly better than that and that's how we came to that 5 percentage based on our bottoms-up projections. These multi-year pricing agreements that we signed with our customers essentially gives us some price stability with the products that they signed agreements with. So, that helps us with our forecasting. It helps us with our planning.

[Operator Instructions] Your next question comes from the line of Jim Sidoti with Sidoti & Co. Please proceed with your question.

Great. Great. Clarence, I feel like I just picked it up. I hope you're not leaving because of me.

No.

All right, I just want to be clear, are you reiterating your annual guidance for the year of $1.30 to $1.45 EPS?

We're not making any changes to the guidance both revenue and EPS.

Okay. I just want to be clear on that. All right. Now, with the Chinese facility, you said you were able to ship product from other facilities which I assume mean Germany and possibly U.S. Was that -- did that have an impact on the gross margin in the quarter?

No, it wouldn't have made any difference in reality. I mean, you're right. That's where product did ship from, probably a little more from Germany than from the U.S. via Trussville. And some of that is just because of -- there's still some tariffs in place that impact product that ship from the U.S.

Okay. And then, the last one for me is, you indicated that you're going to start to include the SOX Sarbanes cost -- Sarbanes-Oxley cost in your EPS. Is that a material number?

It was. So, I think the non-GAAP adjustment for last year would have been probably $2 million to $3 million, somewhere in that kind of a range. So it's not an insignificant number.

Okay. But your guidance from $1.30 to $1.45 that anticipates that already?

Yes. We knew that already going into this. So I mean that was already built into our plans for the year.

Your next question is a follow-up from Anthony Petrone with Jefferies. Please proceed with your question.

Hey. Just a couple of follow-ups to tighten up some of the math here. So, the extra day, I think, Clarence, you mentioned $3 million to $5 million, was that just medical or is that overall? So that will be the first follow-up question just on the extra selling week, the contribution there. And then, in terms of additional OEM deals, I know Canon here was announced. Everyone you think of the top 10 OEM customers, just where are you on the cycle with those customers and are there any expected to be announced over the next year? And then, the last one, I'll just add in here. Just an update on high level numbers on where China OEM orders stand both on the CT side and maybe to a lesser extent on the flat panel side. Thanks.

So, let me start to those latter two questions. Anthony, we don't announce individual customer renewals or transitions. I mean, historically we've only done that for Canon given the size and the volume of that renewal. So, in general, the conversations are top OEMS, top 10, top 15, big group are actually all proceeding very well. These are -- I'm happy to say that we don't -- we're not -- we haven't seen customer leakages or anything significant that we can point to as a problem. So, I'm very, very happy with the way our long-term relationships are continuing to hold and grow. And then, your...

So, maybe to follow on to that I guess as the key point is just that we've got renewed agreements that are multi-year agreements that represent 50% of the medical business. So, this is -- it has to be our larger customers, I mean, to get the math just to be for that to work. So, it puts us in a good place with the major OEMs that are out there and that have been our ongoing customers, and it's a good renewal from that perspective and it sends a strong message to us about their commitment to our partnership with them. Now back to the extra week, basically, if you think about it adds a little bit of production time. Granted it was during a time when you got extra holidays and the like, so it's not super productive from that perspective. But -- so that's how I came to rough number and it's very rough number about how much we get out of that. And so, it's -- but more importantly, I think it's just that, we still -- we had good demand in a variety of other just ongoing applications throughout the quarter. And that's -- that helped us through a strong quarter for the first quarter of the year.

And then, Anthony, your last question about China CT orders and anything else around detectors. So, our China CT customers are the ones who've been working on projects with us. They're continuing to make good progress. And we're seeing good steady and growing demand from them as we had anticipated. And on the mix side, most of what we're seeing currently are their initial CT systems that they rolled out, that there are in the -- where the demand is the highest on the 16 slice. So but we're satisfied and happy with the volumes and the demand and the progress of our customers, CT customers in China. And on the detector side, frankly the -- we -- last year, we had lost a chunk of the radiographic detectors that we pulled from because it didn't make sense for us to sell those given the tariff situation. The production that we've just begun in China are for those radiographic detectors, and it'll take a bit of time for us to get back in the groove with those detectors, but the initial shipments have begun, we've shipped prototypes to customers. They're really happy with it. These are new models, great detectors, and I'm optimistic that going forward, we will start recouping our -- regaining our position in China with the radiographic detectors. Now, we've continued to do steady business in China with some of our high-end dynamic detectors for both Chinese OEMs and the global OEMs. And recall, we also sell industrial detectors in China. So, that has continued on with as business as usual. We're happy now to add some incremental business in China with these new dental OEMs. We're very excited that there are dental OEMs that are introducing the high-end applications and we -- as we mentioned, we signed an agreement with one of them for our multi-year agreement, and we are optimistic that this will be a good one for us to continue on with other dental OEMs in China.

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to Mr. Howard Goldman for closing remarks.

Thank you for your questions and participating in our earnings conference call for the first quarter of fiscal year 2020. A replay of this conference call will be available through February 25th and can be accessed at the company's website or by calling 877-660-6853 from anywhere in the U.S. or 201-612-7415 from non-U.S. locations. Our replay conference call access code is 13698110. Thank you and goodbye.

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