Varex Imaging Corporation (VREX) Q4 2020 Earnings Report, Transcript and Summary

Greetings! Welcome to Varex Imaging Corporation’s Fourth Quarter and Fiscal Year Full Year 2020 Earnings 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] Please note this conference is being recorded. I would now turn the conference over to Howard Goldman, Director of Investor Relations. Thank you. You may begin.

Thank you. You may begin. Good afternoon, and welcome to Varex Imaging Corporation's earnings conference call for the fourth quarter and fiscal year 2020. With me today are Sunny Sanyal, our President and CEO; and Sam Maheshwari, our CFO. To simplify our discussion, unless otherwise stated, all references to the quarter after the fourth quarter of fiscal year 2020. In addition, unless otherwise stated, quarterly comparisons are made sequentially from the fourth quarter of fiscal year 2020 to the third quarter of fiscal year 2020 rather than to the same quarter of the prior year. On today's call, we will discuss certain non-GAAP financial measures. These non-GAAP measures are not presented in accordance with, nor are they a substitute for GAAP financial measures. We provided a reconciliation of each non-GAAP 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 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. Risks relating to our business are described in our quarterly earnings release and our filings with the SEC. 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, everyone, and welcome. Fiscal year 2020 was a productive year for us despite the headwinds created by COVID. First of all, I'm very happy to report that we renewed all of the multiyear agreements with our top 20 customers that became due during the fiscal year. Second, we completed the closure of our Santa Clara facility ahead of schedule and made additional structural changes, which together will result in $28 million of annual cost savings when fully realized. Third, we replaced our existing debt with a capital structure that provides us with increased liquidity and flexibility. And last but not the least, we launched a number of new products. The combination of these and other actions, leave Varex well positioned for future growth once the economy recovers from the impacts of COVID. I'm also very pleased with the performance of our leadership team, our managers and our employees around the world who have navigated the turbulence from this pandemic. And through it all, we continue to fulfill our customers' needs. In the current environment, as we look at our financial performance, we believe our investors will get a better sense of our performance with sequential comparisons more so than year-over-year comparisons. On that note, our fourth quarter revenues were $170 million and were comparable to the third quarter of fiscal year 2020. The revenue mix between our segments was also comparable on a sequential basis. Our margins improved sequentially, largely due to the start of benefits from the cost reduction actions. On a year-over-year basis, total company revenues declined 16% in the fourth quarter due to the ongoing impact from COVID. In our Medical segment, during the fourth quarter, CT tube sales were strong, while sales of our products used in other medical imaging procedures continued to be down. Demand for our mammography tubes increased slightly, but the demand for our general X-ray tubes and detectors was solid, presumably due to the increase in purchases of mobile X-ray systems during the early months of COVID. During the quarter, some of our customers acknowledged that they were seeing an uptick in selling activity in some of their dental surgery and oncology markets. However, while this activity did not translate into significant orders for us in the fourth quarter, we are encouraged to hear this, and we are operationally prepared to respond to any increases in demand. Our R&D teams have been actively engaged with our customers this year with new product development efforts. We recently began to make engineering prototypes of a new family of liquid metal bearing technology-based tubes available to our customers for evaluation. The initial models are designed for CT and cardiac applications, and we have a growing pipeline of customers interested in incorporating these technologies into their future products.Tubes that incorporate liquid metal bearing technologies are expected to have longer life, and we intend to market them with service contracts to the OEMs. We also continue to make progress with our Nanotube technology development with our joint venture partner, BEC imaging. You may recall that about a year ago at the annual meeting of Radiological Society of North America, also known as RSNA, we exhibited a per type of our Nanotube technology in a multi emitter mammography system configuration. And since then, we have received a lot of interest in this technology. We are very happy with the performance of the emitters and the tubes. We are engaged in early-stage product development activity with several OEMs to explore the use of our technology in their future imaging systems. On the detector side, we're in the final stages of commercialization of our new Z Platform detectors. This new technology is initially targeted at cardiac, surgery, dental, and other fluoroscopy systems that need high-performance dynamic detectors that can reduce x-ray dose used during imaging. Since we introduced this platform at RSNA last year, we have released three new Z Platform models that are now available to all our customers. Additional models are in development, and we expect to release them to customers for evaluation and integration during FY '21. I'm pleased to report that a number of OEMs have placed orders for our Z Platform detectors with initial shipments scheduled to begin in the first half of fiscal year 2021. While our sales in our Industrial segment were down year-over-year, we saw very early signs of recovery in some nondestructive testing verticals, such as electronics and battery inspection. In cargo screening, a modest increase in activity led to increased orders and backlog for some of our OEM customers, and we expect that some of this will turn into orders for us in fiscal year 2021. Meanwhile, China appears to have recovered from the initial shutdown due to COVID, and we are very happy with our performance there. In fiscal year 2020, the China market represented 11% of our total company revenues. Our local Chinese OEM customers have continued to successfully bring new CT systems to market. Strong sales of CT systems by local Chinese manufacturers led to a significant increase in the number of CT tubes that we shipped to China in fiscal year 2020 over the prior fiscal year. In a couple of weeks, we will once again be showcasing our latest x-ray tubes digital detectors connection control devices and software solutions at the annual RSNA conference. In particular, we will be introducing two new Photon counting detectors. More information about these and other new products will be included in our upcoming RSNA announcements. RSNA starts on November 29, and this year, it's going to be a virtual event. For those of you that are interested, after RSNA starts, we will have links to our virtual exhibit booth posted on our website and on Varex social media channels. With that, let me hand over the call to Sam to talk about our financial performance in greater detail.

Thanks, Sunny, and hello, everyone. As a reminder, unless otherwise indicated, I will provide sequential comparisons of our results for the fourth quarter of fiscal year 2020 with those of our third quarter of fiscal 2020. Our fourth quarter financial results indicate that our sales have stabilized. Fourth quarter revenues were $170 million and comparable to the third quarter of fiscal 2020. Medical segment revenues were $136 million and Industrial segment revenues were $34 million. Compared to the fourth quarter of last year, revenues declined 16% to $170 million from $202 million due to the effects of COVID. Geographically, fourth quarter revenues were $64 million in the Americas, $55 million in EMEA and $51 million in APAC. For full fiscal year 2020, revenues in the Americas were $255 million, $231 million in EMEA and $252 million in APAC. This reflects a geographically well balanced revenue profile for us. Our fourth quarter GAAP gross margin was 27%. On a non-GAAP basis, gross margin was 28%, an improvement of two percentage points from the third quarter of fiscal year 2020. This increase is due to a favorable product mix and initial benefits from cost reduction. R&D expenses in the fourth quarter were $17 million on both a GAAP and non-GAAP basis. This was a decrease of about $2 million from the previous quarter. Fourth quarter SG&A expenses were $41 million. On a non-GAAP basis, SG&A expenses were $31 million, an increase of about $3 million from the previous quarter, largely due to higher year-end audit fees and pension costs in our German operations. Operating expenses were $58 million. Non-GAAP operating expenses were $48 million compared to $36 million in the previous quarter. This $2 million sequential increase was primarily due to higher SG&A expenses that were partially offset by lower R&D spending. Our fourth quarter operating loss was $13 million. On a non-GAAP basis, operating loss was less than $1 million compared to an operating loss of more than $1 million in the previous quarter. GAAP interest expense in the fourth quarter was $14 million, which was unusually high due to various financing activities, including issuing high-yield notes and paying off our previous credit facility and associated interest rate swap. On a non-GAAP basis, interest expense was $6 million, similar to the third quarter. Other expenses were approximately $2 million. We recorded a GAAP tax benefit of $4 million in the fourth quarter. On a non-GAAP basis, we recorded an $8 million tax benefit. The CARES Act and subsequent treasury regulations allow us to apply current year net operating losses to taxable income from prior year tax filings. And as a result, we expect tax refunds from the U.S. Treasury. GAAP net loss for the fourth quarter was $26 million or $0.66 per diluted share. On a non-GAAP basis, net loss was $2 million or $0.04 per diluted share compared to a net loss in the third quarter of $8 million or $0.20 per diluted share. Diluted shares outstanding were 39 million shares in both the period. Now turning to the balance sheet. Accounts receivables increased by $14 million during the quarter. A large portion of our shipments occurred in the third month of the quarter, causing DSO to go up by eight days to 66 days. Inventory decreased by $11 million in the fourth quarter to $272 million as we completed the transfer of manufacturing at our Santa Clara facility to Salt Lake City. Cash flow from operations was negative $12 million for the fourth quarter, but it was positive $13 million for the full fiscal year. We ended the fourth quarter with cash of $101 million on the balance sheet, an increase of $13 million in the quarter. Total gross debt outstanding was $511 million, out of which $455 million was recorded on the balance sheet due to a portion of the convertible loan being recognized as a component of equity. Let me now give you a high-level summary of our financial initiatives that have either been recently completed or are in process. I will then follow up with an overview of our initiatives for fiscal year 2021. First, I would like to discuss our new capital structure and liquidity. During the second half of fiscal 2020, we put in place a more flexible debt structure that also helped increase our liquidity. Our debt now improved $300 million of 7-year senior secured notes that bear interest at 7.875%. $200 million of 5-year convertible notes that bear interest at 4% and a new $100 million asset-based revolving credit facility that currently remains undrawn. We also carry additional debt of around $11 million in our foreign subsidiaries as well as a cross currency swap. Overall, our weighted average pretax annual interest rate should be about 6.2%, and the annual cash interest expense burden should be approximately $31 million. As of the fiscal year-end, there was plenty of liquidity with $101 million of cash on our balance sheet and another $100 million through our asset-based revolver line. Also by paying off our previous credit facility, we removed the substantial doubt about our ability to continue as a going concern. Second, I would like to provide an update on our cost reduction efforts. As we shared with you previously, we targeted an annualized cost reduction of $28 million, which should be fully realized from the second quarter of fiscal year 2021. Roughly, 75% of the cost reductions are expected to benefit gross margin, and 25% are expected to benefit operating expenses on the P&L. We are largely complete with the closure of our Santa Clara facility with only a few minor steps left to be executed. This specific initiative is expected to provide savings of about $14 million annualized or about $3.5 million per quarter. Additionally, as part of our cost reduction efforts, we reduced 94 positions in the U.S. in the fourth quarter, which is expected to save us an annualized $15 million beginning the first quarter of fiscal year 2021. Let me now move to discuss new initiatives that are in process for fiscal year 2021. The first initiative is a targeted $25 million to $30 million reduction in our inventory during the year through a combination of facility consolidations, implementing additional lean programs, further streamlining our supply chains and discontinuing low velocity products. The second initiative for fiscal 2021 is to reduce costs associated with manufacturing and servicing of our products, particularly in the areas of warranty, manufacturing yields and freight costs. Through this initiative, our target is to improve gross margin by one percentage point towards the end of this fiscal year. Let me now provide you our business outlook. Given the current economic environment, we are changing our prior approach of providing annual guidance in favor of providing quarterly guidance. We believe quarterly guidance will help investors better understand our business performance and progress. Accordingly, for the first quarter of fiscal year 2021, we expect revenues to be between $160 million to $180 million. And we expect non-GAAP earnings per diluted share to be between negative $0.15 and positive $0.10. These expectations are based on non-GAAP gross margin improvement to a range of 30% to 31%, which includes some benefit from the closure of our Santa Clara facility. Non-GAAP operating expenses reduced to a range of $44 million to $45 million and non-GAAP interest expense around $8 million. With that, I would like to now hand the call back over to Sunny for some closing remarks.

Thank you, Sam. So looking beyond COVID, we expect demand for X-ray imaging equipment and for our products to rebound once the effect of the pandemic is past us. We are confident that our continued focus on innovation will enable us to position -- expand our position as a market leader across all product lines in our core business. Our goals for the next phase of growth, which we have referred to as Varex 2.0 are focused on accelerating organic growth, improving operating margins through operational transformation and strengthening our balance sheet. With the debt refinancing actions, we've already positioned ourselves with a new capital structure that gives us operating flexibility and strengthens our balance sheet. Our next steps here are to improve our financial performance and lower our debt. To do that, we will continue to drive initiatives to improve gross margin and operating income. Our initiatives -- our investments in the R&D are aimed at enabling Varex to expand its footprint within our customer base as well as for opening new addressable market opportunities with Photon counting detectors and Nanotube x-ray sources. I'm happy to say that we're making good progress in each of these areas of Varex 2.0, and these goals are reflected in our fiscal year 2021 operating plans and management incentives. With that, we will now open up the call for your questions.

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

And I hope everyone is doing well and staying healthy. Maybe a couple for Sunny, and then I'll have a few for Sam, as it relates to some of the guidance metrics that you provided, Sam. And so Sunny, maybe from a high level, you gave updates here on where each of the businesses is trending amid the COVID sort of resurgence. And so I guess, at a high level when you consider, in particular, where you referenced Industrial, you are seeing some signs of a turnaround in select areas of Industrial, so maybe describe how you see that trending into '21 from here, in particular, when you consider that we do have a resurgence in some geographies and a lot of key geographies for that matter? And then if you can refer to China, it sounds like its business back to usual. So is that a fair way to describe where China is exiting the quarter? And then I'll have a few follow-ups.

Yes. Okay. So thanks Anthony, for Industrial, the way we experienced the situation is that initially, when the full impact of COVID hit everyone around the April-May time frame, everything stopped, right? So we had lockdowns everywhere and all activity essentially seized. And then airports stopped operating most of their gates and we saw serious slowdown there. So that's how it started out. And then as COVID progressed and as -- what we're seeing now is that the Industrial side of our business and those markets and those different verticals within Industrial are pulling away from -- in their recovery trajectory, they're pulling away from the way. Medical is recovering. And what I mean by that is, look, airports have been shut down. They're going to stay shut down for some time. There's no improvement or degradation there. But meanwhile, in other verticals, as -- as you know, Industrial is very fragmented and there are many sub verticals. As you look at different verticals, they're progressing along different trajectories. So I mentioned electronics and battery inspection. We're seeing continued strength in that area, and there was strength pre-COVID, and it returned to increasing levels of activity. So what we're seeing, what we're anticipating is that within Industrial, it won't be an all or nothing. There isn't -- it isn't tied to one large group of entity's capital budgets like we have that in the Medical side. In the Medical side, we're pegged to the hospital capital budgets globally. However, on the Industrial side, given the fragmentation of the verticals, we're seeing different trajectories. And each -- sorry, different dynamics within each sub vertical, and they have their own little trajectories. So on balance, what we expect is that the government -- all the verticals controlled by government, government spending will continue to move forward. We were encouraged by the tender activity in the cargo screening area where some tenders were finalized, and our OEM customers receive some orders. Similarly, we've continued to see spend on the government side or the activity continue to stay active. And now what we expect is that the other Industrial verticals in food inspection, general manufacturing will continue to evolve on their own. AND even if -- even with the situation with COVID, we're not anticipating a regression in any significant way. So that's the scoop on how we see Industrial evolving during this recovery.

Okay. And then again, a follow-up on the China CT 2 market in particular. So maybe just a follow-up there on where that business is trending, and it does sound like that is sort of completely back to business, pre-COVID levels, is that accurate?

Yes. So we're very happy with our performance in China. And so they were shut down for about eight weeks this year. And when they came back up, they went right back to work, and they caught up with their prior trajectory. So from that perspective, all the things we've said about the China market have continued to play out just the way we have explained it, which is their -- Chinese government continues to make investments in health care. The purchasing of CT continues, and through the COVID pandemic, while we saw an uptick in the buying of CT systems and X-ray systems in a post -- they went through a peak of their own. And beyond that peak, we didn't see the CT market subsiding or anything like that. The trajectory that they want -- that they were on previously appears to have continued. So we are we're happy with the way things are going in China. Our OEMs have not slowed down in their product development efforts. They're continuing on with their plans. Any slowdowns or any delays there are typical to our normal R&D cycles and processes. So for all practical purposes on the Medical side in China, it feels like business as usual.

And then I'll shift gears and get back in queue. Here for Sam, just up on, one on expenses and then one on the guidance range for 1Q. Just when we look at the operating expense level, and I know some of the savings are going to evolve as we head into fiscal '21. When we look at the fourth quarter level, $48 million in OpEx, should we be gradually seeing more savings on that line as we run through fiscal '21? So that would be the first question just how to think of the quarterly cadence on total OpEx vis-à-vis the fourth quarter. And then the second question would be on the guidance range, in particular, for 1Q, it's a $20 million spread on the top line and a $ 0.30 or $0.25 kind of range on the bottom line. And so maybe walk us through the lower end of that range would sort of you kind of factoring in the variables that can drive it to the upper end of the range?

Sure, sure. Let me address your questions one at a time. So in terms of OpEx, we are guiding a significant improvement for Q1 versus Q4. So Q4 was at $48 million. There were certain expenses in there that should go away as we round out the audit and the 10-K filing and all of that stuff. So essentially, we are guiding $44 million to $45 million beginning with Q1. So all the positions that we eliminated in the July, August time frame, they are beginning to use is a big starting from, say, October. So that's why that run rate is going to go straight from 48% to, say, 44%, 45%. And then it should remain at those levels throughout the year. And if you would remember, last quarter, I had guided OpEx for the full year in the range of about $175 million in that range for the year. And say $43 million to $45 million per quarter by Q2 of 2021. So I'm glad to say here that we are already at that range, $44 million to $45 million and that's how that will build up. Some of the other cost reduction initiatives that we've been taking on, for example, Santa Clara and some other position eliminations. You are going to see that benefit in the continuous improvement in gross margin. So we just did 28% and guiding 30% to 31%. And as Santa Clara benefits fully begin to get realized, I expect gross margin to sequentially improve during the year couple one or two percentage points from one quarter to another. So I expect gross margin to be nicely building up during the year based on our initiatives. Then lastly, in terms of your guidance range, yes, so the revenue is $20 million on the top line and the bottom line is at about $10 million. And what really is happening here is we are in quite uncertain environment, given COVID and all of that. But at the same time, there are a few things that can change on us, which is -- which you know, Anthony, you've been with us for some time here, given the mix, the mix can change. The lockdowns have started to happen in Europe, et cetera. So we don't really know what exactly the type of mix that would come. We feel good about the quarter in terms of where we are. We are halfway done with the quarter. So we feel good. And the next quarter is also beginning to Form on a similar trajectory as this quarter. So we feel good about that quarter also. But you never know, there can always be a shipment push out by any one of our customers. So that's the revenue difference. And then mix can drive a change to our gross margins. And then lastly, taxes can be different because we are closer to breakeven. So taxes on a GAAP basis start to behave in very unpredictable manner in a way. So that's the reason for some of this range essentially.

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

Just a few follow-ups. First on Anthony's question. On the cost side, did you see any benefit, I guess, on the, I guess, would be from the closure of the facility in Q4 at all? It sounds like the operating expenses and the headcount reductions were all going forward. But did you get any benefit at all? Or do we still get that full $14 million benefit coming?

So Larry, there were some benefits, but very, very small. The bulk of the benefits would begin to show up from Q1 for the positions that we eliminated. And Santa Clara, the $14 million, I expect half of it because it's kind of a situation where we are ramping the cost savings in a way during Q1, so essentially half of Santa Clara benefits are going to roll through Q1. And when you look at that $28 million cost reduction program, 25% of that is in OpEx and 75% is in COGS or gross margin. And when you look at that, and if you just take simple numbers, Santa Clara is half of it and position eliminations is half of it, so half of Santa Clara is going through in Q1. Remaining will go through completely through the P&L in Q2. And then all of the position eliminations, they would benefit our OpEx in Q1.

Got it. Okay. That makes sense. And could you -- just a question, I know you don't break out the adjusted gross margin between Medical and Industrial. But I just -- I noticed that the GAAP Industrial number was over 41%, so that you never up a non-GAAP 40% number and going back two years. So I'm just trying to -- was there something in that number that unusually about to be benefited?

Yes. So Larry, the way to understand it is that at these low levels, as you remember, in our Industrial business, we have machine sales as well as services. Services are on contracts and all of that. So what happens is these margins behave somewhat erratically when the machine sales are low. And we are really going through a very low period in the Industrial business from a new machine shipments or installation perspective. And that is what explains that type of gross margin behavior there. I would not suggest that the margin profile overall for the business is trending in that direction.

I was actually more concerned that maybe that was a one-timer? Or on the flip side, the Medical margins are worse than I thought potentially. So that's really why, I was just -- yes.

Yes. It's just the mix within the Industrial segment of machines versus service and time and material type of service.

Okay. Okay. No, fair enough. And then just switching gears just to the revenue trends. I realize you're a component business and somewhat down the -- not front end has the elective surgery start to come back you won't see that benefit probably for a little while. So -- but in that vein, elective surgeries that certainly come way off their bottoms. I realize COVID's consensus is not improving anytime soon, although it does seem like in most of the medical world, people are -- maybe there was some pent-up demand that causes, but people are at least trying to get back to, especially for things I absolutely have to do. Have you seen any, at least anecdotally customers that hospitals may start to purchase things as we go out to '21? Will you get any better visibility maybe with capital budgets coming out in the beginning of hospital fiscal years or any better clarity on that? Or are you still kind of very uncertain timing?

Larry, this is sunny. So the activity that our customers are seeing varies by geography and varies modality. So as we mentioned in activity in China has been for all practical purposes, seems like every day normal business. But that's -- so in rest of Asia, rest of Asia is slower. Pre -- before the second wave or these lockdowns that began in Europe, our customers were saying that they were encouraged by seeing increased tender activity. And so there was more quote activity and quotes were going out. And so that was a positive thing, and they were feeling good about it. Now, of course, with these current set of lockdowns that'll probably slow down a little bit because communication slows down, et cetera. And then in Americas, North America -- Americas was slower and slowest. So that's on a region basis. From a modality perspective, what we saw was, mammography was one of -- mammography and dental were the two that initially stopped very quickly, right, because these were in outpatient areas. But then the return also feels like it seems like as a modality, they respond quicker. They stop quicker -- sooner, they really come back faster. So that's how we're seeing so we did see an uptick in mammography. Now that's coming largely because, as you mentioned, as these elective -- I'll just call it mammography screening is elective in that context. As people go back to the offices open up and people go back to their screening activities, the usage of the systems then drives the replacement tube revenues for us. So we've begun to see an uptick in -- as hospitals have become more active and outpatient imaging centers are more active, we're seeing replacement tubes volume picking up. So that's where we're seeing it. In terms of capital equipment purchases, we haven't seen anything conclusive one way or another. But we have seen pockets of increased activity, which are encouraging.

Okay. Just take one on the product side, so you mentioned the Nanotube technology, and you sound very excited about that. When might we actually see some commercialization of this? It sounds like we still -- are we still several years out from that or?

Yes. So Larry, as you look at our -- this is the -- can be a frustrating part of our basis, right? That time to revenue tends to be long. If you look at the product life cycle from the point where we have, first, we developed the foundational technologies. And when we have it, we take into our OEMs and they start evaluating it, and then they start designing their imaging applications around it. And then they bring it to market. So we're at that stage, where we feel good about the foundational technologies. That initial phase of development is moving along very well. And now we're making samples available to our customers who are now characterizing them. And then -- so this R&D process continues on. So directly to your question, frankly, it'll be 2-plus years before we see anyone bring a system to market. But the good news is once they bring it to market in the next 15, 20 years, we stay engineered in there, right? So that's upside?

Yes, absolutely. Yes. That's right. Yes, fair enough. And obviously, hopefully, several, you can swell come to market, and that would be great.

Right.

Yes. Absolutely. Just last question, just on the cost again. I guess the 100 bps gross margin targeted improvement will be a gradual type thing that you hope to sort of reach full run rate as we head into fiscal '22? Is that fair enough? And that would be like a $6 million, $7 million, $8 million type thing, if we just based on run rate revenue?

Yes. So Larry, I think, as I said, we started working on them, but these are -- these things move slowly. I'm hoping that it has a beneficial impact in the second half of fiscal 2021 here. So our target would be that for sure, FY '22 gets the help of a full one percentage point. But I'm hoping even for Q4 of this fiscal year, we are able to get the full percentage point for.

Okay, great. So you'll get some gradual improvement, maybe not in Q1, but maybe a little bit even in Q2, Q3 or if you going to get to that fall level?

We are going to go a little bit slow in Q1, Q2 and then pick up in Q2, Q4. So Q1, Q2, I will not count too much on that.

Our next question is from Suraj Kalia with Oppenheimer & Company. Please proceed.

Sunny, Sam, Howard, I hope everyone is safe and healthy. Can you hear me?

Yes, we can.

So Sunny, a bunch of questions for you and some for Sam. Let me start out on a high level, sunny. Obviously, you guys were forced into a tricky position with this whole nonsensical China tariff thing. Now with the new administration on the horizon, do you anticipate any realignment that potentially could offer some incremental benefits, whether it's in workflow logistics, product streamlining, a locally manufactured product? Any additional color there would be great.

Okay. So let me take that. As you -- so as you might recall, that we got hit by tariffs in the beginning, and we reacted very quickly to that. And one of the things we did was set up local manufacturing. We said today, it's China, tomorrow might be India, somewhere else, how do we make ourselves local for local. So our good news here is that our local-for-local initiative, which is the manufacturing in Wuxi is up and running for detectors and tubes, we've had multiple models, many models of tubes, many models of detectors being built. So in a way, we're in a situation where, at this point, for what we need to sell in China, we feel confident that should there be a reverse -- I mean, if there's a turnaround and it's reversed, that's great. It will be helpful. But if the tariffs continue or if the tariffs increase, we are hoping that what we have done by putting in local manufacturing and local sourcing in China that we will offset some of that risk and create a bit of a hedge for ourselves. That's how I'm looking at it. Hard to tell which way things are going to go with the tariffs. I don't think -- I mean this -- it will be totally speculative for me to say something. I mean, I really don't know. All I can say is we saw that we -- this is not something that would allow for to dog our business in the future, and that's why we took the steps of locals were local like we did.

Fair enough. Sunny, you and I have talked a number of times about your core cato technology. Obviously, there is a lot of buzz about this new approach and potentially paradigm-shifting approach to Photon generation and X-ray generation. So Sunny, you made some comments specifically, if I heard you right, you said it will be ready in two years. You guys are in life cycle testing. Let me frame the question a little differently. How do you balance the cannibalization that could occur of existing versus new sockets with this new approach? Have you all done the internal price points? How would this work? Any color there would be great.

Yes. Yes. So in terms of life cycle testing and those things, those are all stuff that's underway, and they will continue on. So the work that we're doing now is in parallel with that. So now, we're giving these samples of tubes, so to say, engineering samples to our customers. So they can understand how they behave, how they operate, so they can start thinking about what types of applications and modalities would be useful for this. Now, in terms of with this cannibalized existing product line and technologies, look, first of all, I expect -- what I expect will happen out of this is that we will get a lot of new customers. That -- obviously, that's what we would be pushing for. OEMs that didn't use our technologies, and there are people that are lining up to evaluate these are -- I'm really happy to see that a lot of new pins, right? So that's -- from my perspective, that's a good thing. Then in terms of cannibalization of existing technologies, well, there -- that could happen. If one of our existing customers decides that their next version of XYZ modality will use the Nanotube-based tubes. So be it. What we are going to do is to -- we have -- we're not at that stage to have set pricing in those other parameters, but the intent here is that this thing has very significantly different and new value proposition. So I would expect that this would be a net very positive thing for us to rather cannibalize ourselves and put out something that's technologically far superior and brings a lot of additional value and advantage. So it'll be that positive thing for us, even if it replaces our existing product line. Now we still have -- remember, we have that any customer that builds this into their new application still has a very large installed base of the other technologies, right, which we will continue to supply. So this becomes a new in a way a new revenue stream for us for the future. People -- but I guess what I mean is people are not going to retrofit this into an existing product line. It's going to be mainly a new application and a new revenue stream.

Right. No, I get it. I was just curious if you all anticipate any of the existing sockets when the equipment life cycle is up. And the new -- the new machine of the replacement would that incorporate? If and all, it incorporates the coal cathode technology and then there are ramifications for replacement cycle and all that. But I get your point. I guess a couple of follow-ups, if I could, for Sam. Sam, just following up on Anthony's question about the $20 million spread on the top line. I'm not sure I heard about your implicit expectations for the Medical versus Industrial. And the reason I ask is, if I look at the Medical or for that matter, Industrial, right? It isn't clear to me that things have bottomed out, especially on the Medical? But maybe you can sort of give us a flavor of how you are thinking in terms of this guidance? And the second part of my question, and I'll just plug that in now. Sam, you all mentioned about improvements. I was just making notes. You said streamlining existing manufacturing operations. Would this offset any gains from the Santa Clara shutdown? And as I was scribbling notes, what I wrote was about 1% to 2% incremental improvement in gross margins every quarter. So should I think that as we exit next year, we are probably talking gross margins, GAAP gross margins in the 31%, 35-ish-percent range? Or did I get that wrong?

Sure. So Suraj, I'll address your second question first here. So the bit where I talked about, improving manufacturing yields, warranty, et cetera. That's what I think you were referring to. That is incremental to Santa Clara related cost savings. That's one. I do -- and I just want to highlight that, that entire initiative for FY '21 will give us an improvement of one percentage points in gross margin. So I just want to make sure that it is not 1% every quarter. So the way gross margin is lining up here is that, this coming quarter, we have some benefits from Santa Clara shutdown. The following quarter, we would have full benefits from Santa Clara shutdown. And the following quarter, we would have some benefits coming in from our warranty and yields and some of those initiatives. And so that is how gross margin is ramping up. So if you take all of these numbers that I have highlighted here, I think you are going to see that you'll probably be looking at 32%, 33% type of gross margin by the time the year is ending as opposed to, say, around 33% as opposed to 35% that you mentioned. So that is one thing I want to highlight, and these are all non-GAAP numbers. And then coming back to your first question in terms of the top line and the variability around that, in that, Christmas season is coming in and COVID is also flaring up here and there. And this is why we are highlighting a $20 million range on the top line. It is possible that some facilities that our customers have, they may or may not be able to take our shipments. So, so far, there is no such news knowledge that we have, but we are just being cautious about it. And that is why we are giving this range. It's really the known unknown, so to say, at this point, which is what we are incorporating. But in general, our guidance, both for top line and also for our EPS guidance, we track towards the midpoint of the guidance.

Our next question is from Jim Sidoti with Sidoti & Company. Please proceed.

Good. Hope everyone's well. A couple of quick questions. You talked a little bit about the samples or prototypes that you have out in the field now with some of your old young customers, how long does it take for that to convert to orders?

First of all, if it's an existing technology like on existing tubes, existing detectors. Usually, that process is between 12 to -- somewhere between 12 and 24 months. Tubes take longer to integrate. Detectors are usually faster. This is a brand new technology. I think you're referring to our Nanotube based its brand new technology. It's something entirely different and new. So my expectation, Jim, is that it'll take a little longer. First of all, customers have to figure out what the existing can do for them, and they have ideas, then they have to do a lot of design work in redesigning of the modality and maybe a whole different way of thinking about what they're going to do. So it'll take some time. It'll take longer than normal. So we're not putting out anything out there in terms of our trajectory or time lines or revenue trajectories. All I'm saying is that it'll take two to three years for people to bring something to market with this technology.

And Sam, did you indicate whether you think you'll be cash flow neutral, cash flow positive next year? Or did you make any comments regarding that?

I did not make any comments, but I'm happy to provide some color on that. In terms of what our cost reductions in, I think at current levels, after this next quarter passes, we should be cash flow breakeven at these levels, essentially. Obviously, what all we are working on is to reduce costs and improve gross margin, and that should begin to play. But the bigger thing is we would like and we would and everybody does want recovery to happen. So we are nicely positioning ourselves from a cost structure and gross margin perspective to be able to receive the recovery well, and that should really improve the cash flow performance of the business.

Okay. And were there any additional staff reductions in the fourth quarter?

Yes. We -- early in fourth quarter -- sorry, not early, say around mid of fourth quarter, we had about 94 positions that were eliminated in the U.S. So that staff reduction was there. And then a little bit of -- there are a few other small actions that are still being work done. We haven't completed them fully, but they are a minor pace compared to what was done in July, August.

So is it fair to say the bulk of the staff reductions are -- you're past the bulk of the staff productions at this point?

Yes. I think that is very fair to say that bulk of the staff reductions are behind us at this time. That is fair to say.

So I mean if we look at the guidance you gave for the first quarter of fiscal '21, it sounds like you're putting comfortable with the level of the staff like we have right now. I know you don't want to go out and give long-term guidance, but is it fair to say that you think that things are pretty much bottomed out the last two quarters and that you don't expect the business to deteriorate significantly from the level it is right now?

So Jim, in general, we would never say never a green type of a thing, but in terms of our business, look, Q3, Q4, we have that it has stabilized. It has stabilized, although at a lower levels. We are just waiting for the recovery to happen. So I think your understanding or your interpretation is correct. We are not seeing any further degradation of our business. It seems to me we kind of bottomed out, maybe, say, July in terms of the month-to-month performance. And so that's where we are. But at the same time, major piece of recovery, we are still waiting for, and we will be ready for it as it comes. We are taking this time to get our cost structure and gross margin structure all in line. And as top line increases from where we are currently, it should provide a nice tailwind to our overall performance, including gross margin and operating margin.

We have reached the end of our question-and-answer session. I would like to turn the conference back over to management for closing remarks.

Thank you for your questions and participating in our earnings conference call for the fourth quarter and fiscal year 2020. A replay of this quarterly conference call will be available through December 1 and can be accessed at the Company's website or by calling 877-660-6853 from anywhere in the U.S. or by dialing 201-612-7415 from non-U.S. locations. The replay conference call access code is 13712445. Thank you, and goodbye.

Thank you. This does conclude today's conference. You may disconnect your lines at this time and thank you for your participation.