Greetings, and welcome to the Varex Q1 2024 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Christopher Belfiore, Director of Investor Relations. Thank you, Chris. You may begin.

Good afternoon, and welcome to Varex Imaging Corporation’s earnings conference call for the first quarter of fiscal year 2024. With me today are Sunny Sanyal, our President and CEO; and Sam Maheshwari, our CFO. Please note that the live webcast of this conference call includes a supplemental slide presentation that can be accessed at Varex’s website at vareximaging.com. The webcast and supplemental slide presentation will be archived on Varex’s website. To simplify our discussion, unless otherwise stated, all references to the quarter are for the first quarter of fiscal year 2024. In addition, unless otherwise stated, quarterly comparisons are made year-over-year from the first quarter of fiscal year 2024 to the first quarter of fiscal year 2023. This is a change compared to prior quarters where since COVID, we have compared results sequentially. We believe going forward, this will be a better representation of our results given that the impacts of COVID are largely behind us. Finally, all references to the year are to the fiscal year and not calendar year unless otherwise stated. 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. 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. I will now turn the call over to Sunny.

Thanks Chris. Good afternoon, everyone, and thank you for joining us for our first quarter earnings call. Revenue of $190 million in the first quarter of fiscal 2024 was in line with our expectations. Lower volumes and unfavorable mix in both Medical and Industrial segments impacted profitability. As a result, non-GAAP gross margin was 31%, and non-GAAP earnings per share was $0.06. Revenue in the first quarter was down 8% year-over-year. Revenue in the Medical segment decreased 13% year-over-year, while the Industrial segment revenue increased 10% year-over-year. Non-GAAP gross margin in the first quarter was 31%, which was below our expectations and down approximately 100 basis points compared to the same quarter last year. Adjusted EBITDA in the first quarter was $19 million and non-GAAP EPS was $0.06. We ended the first quarter with $195 million worth of cash, cash equivalents and marketable securities on the balance sheet, up $87 million compared to the first quarter of fiscal 2023. Let me give you some insights into sales detailed by modality in the quarter compared to a five-quarter average, which we will refer to as the sales trend. In our Medical segment, global sales of CT tubes were seasonally softer than usual and below its sales trend. Fluoroscopy and oncology modalities were weaker in the quarter and were below their respective sales trends. The lower volumes in these three modalities contributed to the unfavorable mix in the quarter for Medical. Dental improved slightly in the quarter, but remained below its sales trend. Mammography continued to be solid with revenues above the sales trend in the quarter, while radiographic was below its sales trend. Global sales of our industrial products in the quarter were solid, but below its sales trend in the quarter. We continue to see strong momentum in our cargo…

Thanks Sunny, and hello, everyone. As a reminder, the first quarter is generally a seasonally low quarter for us. Our revenues were at the midpoint of guidance, while gross margin was below the guided range and non-GAAP EPS was lower than the guidance midpoint. During the quarter, we experienced unfavorable product mix in both Medical and Industrial segments, along with seasonally low volumes. As a result, revenues were $190 million. Non-GAAP gross margin was 31%, and non-GAAP EPS was $0.06. Further, operating cash flows were $10 million for the quarter. First quarter revenues decreased 8% compared to the first quarter of fiscal 2023. Medical revenues were $140 million and Industrial revenues were $50 million. Medical revenues were 74% and Industrial revenues were 26% of our total revenues for the quarter. Looking at revenues by region. Americas decreased 6% compared to the first quarter of fiscal 2023, while EMEA increased 1% and APAC decreased 16%. As highlighted last quarter, the decline in APAC was primarily the result of lower sales in our China business due to the government's anticorruption campaign into its healthcare system. China accounted for 17% of overall revenues in the first quarter, even though sales in China declined approximately 10% compared to the same period last year. Let me now cover our results on a GAAP basis. First quarter gross margin was 30%, 100 basis points lower year-over-year. Operating expenses were $53 million, up $3 million compared to the first quarter of fiscal 2023, and operating income was $4 million, down $9 million. GAAP net loss was about $0.5 million, and EPS was a loss of $0.01 per share based on fully diluted 41 million shares. Moving on to non-GAAP results for the quarter. Gross margin of 31% was down 100 basis points compared to the first quarter…

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question comes from the line of James Sidoti with Sidoti & Company. Please proceed with your question.

Hi. Good afternoon. Thanks for taking the questions. Just want to confirm with China, it sounds like revenue for the quarter was about a little over $32 million this quarter compared to a little over $36 million a year ago. Does that sound about right?

Yeah. So Larry, this quarter, yeah, they were about slightly above $32 million. And then last year, they were mid-30s, 34%, 35%, something like that. Sorry.

That's fair. All right. No, I don't mind if you call me Larry. He's a smart guy. It sounds like the decline was less than it was in the previous quarter. So, are you starting to see things level off there?

So, China continues to remain soft due to the due to two reasons; the macroeconomic situation in China as well as the anticorruption campaign there. But from quarter-to-quarter, you're going to see some variation, Jim, just because we're talking $1 million or $2 million here or there. But overall, it is soft. And also, we are hearing that the anticorruption campaign kind of moves from one province to another. So, you're going to see some variation or some fluctuation around that. But overall, China is still continuing to be low.

Right. And then on last quarter's call, you talked about some initiatives for some products and non-organic infection and even the products. Can you give us an update how that's going? I'm sorry, or it was, I guess, organic products, things like cannabis.

Jim, so we did launch our irradiation product, and one of the first applications of that was in cannabis radiation. Yeah. That's going well. The product is showing well, and we've got a few customers on it, and it's moving forward.

So, if I look at the guidance, you're expecting revenue to be down again in the second quarter, and I assume that's largely due to the situation in China. Do you think that by the time you get to the second half of the year, do you think those trends start to reverse and you get back to top line revenue growth in the second half of the year?

Yeah. Jim, as we mentioned in the prepared remarks, we are expecting a rebound in second half. The rebound in second half is gated or it's dependent upon China coming back as well as somewhat of a pickup in Industrial segment. Right now, we are seeing softness in non-cargo domains of Industrial, particularly in semiconductors, automotive and electronics related applications where our product is sold in the Industrial segment. So, we are expecting both of them to pick up at this time, and that should drive a rebound in second half for us. So that is what we are expecting at this point.

And you talked about new product launches on the Medical side, our customers are starting to talk about that. How long does that take to turn into a real product and real revenue for Varex?

So, a lot of the conversations around successor products. Someone has got a CT scanner in the market, it's going to bring the next CT scanners. Those tend to be in -- usually within a two to three-year window. Those are at a fairly short cycle. So, a lot of the conversations that we're having were in that vein of the next modality -- next version of the modality and the next markets tier that they want to go after. And then, of course, in the longer term -- longer cycle -- cycle times are for the newer platforms, like photon counting and nanotubes or anything brand new. Those tend to be five-plus years. Although photon counting is -- we've been talking about it for some time. It's getting closer.

Okay. All right. That was it for me.

Thanks Jim.

Thank you.

Thank you. Our next question comes from the line of Anthony Petrone with Mizuho Group. Please proceed with your question.

Thanks Sunny, Sam. Hope your afternoon is going well. Maybe revert back to China. Just a couple of questions there. You mentioned, one, the anticorruption headwind, but also just underlying economy. On anticorruption, is there anything you're hearing on the ground as to when the program can be completed? Is it safe to assume that it can be completed by midyear? Or could it extend further into the year? And when you talk about just underlying economic pressures, that's a new one. Is that something that you're hearing most recently from OEM partners in the region there? And then I'll have a couple of follow-ups.

So, let me -- Anthony, this is Sunny. I'll get it started and then have Sam chime in and add on. There were two -- there are always two parallel situations. One is the general health of the provinces, economic health of the provinces post-COVID after they spent a lot of money on their zero COVID policy. That was there always in the backdrop. But however, the direct slowness, we could attribute to the stop in purchasing due to the audit that was going on. What we're sensing now is that the audit is -- the audits made substantial progress. And as Sam said, it's just -- it's moving along through the provinces. And the expectation still is that it will start to taper off towards the second half. Now our understanding is that the audits don't necessarily end there. It's a new sort of a way for the Chinese government to monitor and manage how the monies are handled by the public hospital system. So, I think, in general, what we're sensing is a slight, I'd say, loosening up of the environment. And so that's why we still continue to be able the belief that the second half, we should expect to see things pick up in China.

And I can just add there, Anthony, is that you know that there is no specific announcements or there are no sharp cutoff dates or deadlines, that are announced. It is generally as we perceive and hear from our salesforce. So, we just need to be open to that and there can be various interpretations. But in general, we are thinking things will improve because the government does want to spend money on the infrastructure and provide better healthcare facilities and services to its citizens. So, there is the positive pressure there along with, we would say, taking care of the healthcare system for the long-term goodness of the system. So in that way, that's also positive for the long-term.

And maybe just a quick one there. I mean, is it safe to assume then just the -- I guess, the lead time on new deals is maybe slightly longer here because this audit process may be continuously going on in the background? Or are there certain like checks and balances upfront before a deal is closed, whether that's in the provinces or major coastal cities. Just kind of the mechanics of what's going on behind the scenes there would be helpful.

Since we don't have direct visibility to end user hospital buying, I can't answer that very accurately for you. But the way we see it is the hospital purchasing just stopped at some point because of -- they were in the middle of the audits. But once the audits are completed, the hospitals go back to their normal operating mechanisms. And so, whatever was the deal cycle -- the cycle times, we anticipate that, that would come back for those particular hospitals. And for us, the lead times then come back to what would be normal traditional lead times. So as hospitals start taking orders, they might have -- I'm sorry -- as vendors start -- or OEMs start to take orders, they may have three to six-month delivery cycles. And that's when we get the indicators for the -- for our forecasts and our factory would then build the component. So, I don't think anything gets extended once it turns on, it just comes back on in the way things were. So the question is, it's not all at the same time, it's going to start trickling in. And we're seeing early signs of a little bit of that happening.

Thanks. And last one for me, I'll hop back in, is just an update on photon counting on the CT detector side. Just maybe where we are in the cycle, what you're hearing in terms of demand for conversions on -- into photon counting, and how you expect that to play out over the next couple of years? Thanks.

Yeah. So, it's safe to say that the technology is here to stay in the sense that there's -- outside of the OEMs and the vendors like us making the noise around the technology itself. The broad-based radiology community has picked up on photon counting as a viable technology and clinically exciting for them. So from that perspective, we believe it's here to stay. And we are seeing that in the way our medical OEMs are beginning to talk about their future products and the need to incorporate their desire to incorporate photon counting technologies. From a CT perspective, the initial introductions were at the high-end of the spectrum of CTs, but the need in the market is for it to be more in the general tiers that are more broadly available. And we are targeting that type of a market segment and our products are geared towards CTs that would be in that not super ultra-high-end, but things that would be more broad-based.

Thank you. Our next question comes from the line of Suraj Kalia with Oppenheimer. Please proceed with your question.

Hi, Sunny and Sam. This is Shaymus on for Suraj. Thank you for taking your questions.

Hi, Shane.

Hi. Just looking at kind of outside of China, what are you seeing in terms of the capital equipment environment? And then kind of more specifically, I think you noted in the geographic mix, the Americas was down as well, and EMEA was pretty much flat. I guess, any color you could provide there as to what's happening to in those regions as well?

So our perception and our -- what we're picking up is that the hospital environment in the U.S. is -- our hospitals are generally doing better from a profitability standpoint, they're cost structure, labor costs and tie to nursing and clinicians as manpower has gotten better, and so they're managing it better. So, there's profitability improved. So that generally bodes well for capital availability for diagnostic imaging. So, we are -- we feel positive about the U.S. market. Outside of that, we haven't noticed any measurable difference in Europe or let's say, Japan. Those are our two biggest regions. So, I think U.S. continues to be strong. Europe is -- and Japan is still to be seen.

Got it. Thank you. And then looking at it, the Medical segment was down a little bit. I guess, how should we think about the relative health over the next three to four quarters? And where would you describe any soft spots that maybe need to be monitored.

So, I would say in Medical, you're looking at Q1, which is generally a seasonally softer quarter. So, when you're comparing to Q4, you might see that it's a little bit down. But we did indicate in our prepared remarks that we are seeing -- we saw trends in oncology and CT, et cetera, in Q1, which was somewhat softer. So, what I would say is that CT, we've been now growing continuously for five years in a row. So that business is doing well. It's just a quarterly situation and then also impacted a little bit by China. So, we expect CT to come up as China comes up. Other than that, there really isn't anything major that we are seeing, which is the takeaway here, Shane, other than that.

I think in the last couple of quarters, we talked about how our customers' environments have been choked manufacturing environment due to supply chain issues. And so they had -- in some of these modalities that are down, they had stocked up. So, we saw some inventory adjustments and softness. And CT -- part of the CT bounce back will also happen as China starts to come back.

Got it. Appreciate that. And one last one from us, and then I'll hop back in queue. Just any latest thoughts on the convertible debt, how you're going to potentially address it? And I guess, what's the optimal structure that if you had your choice you'd be looking for? Thank you.

Sure. Yes. So, we are currently considering various approaches to refinance the convertible debt. And as and when we make a decision, we will be sure to share with all of you. I just want to remind that the debt is maturing next June, which is June of 2025. So that's an update on the convertible bond side. Secondly, in terms of overall structure, we would like to bring down the overall gross debt that the company is carrying, and I would like to see that we maintain overall adjusted EBITDA based net debt leverage ratio to be 3.0 or below. Right now, we are running at around 2.0, so we are fairly comfortable with our overall leverage situation. I would also say that we are currently in an excess cash situation, and we are purposely carrying excess cash on the balance sheet to deploy some of that for the refinancing purposes and bring the overall gross debt for the company down.

Thank you. Our next question comes from the line of Larry Solow with CJS. Please proceed with your question.

Great. Thanks. Thank you for taking the questions. And thank you, shout out [ph] to Mr. Sidoti. I appreciate the thoughts.

Sorry, Larry, for that.

No, that's okay. Well, that's all good. I'd say a lot of work by the people. So that's fine. I guess, first question, just on the Medical side, and you touched on it a little bit, but ex-China, I guess, it looks like you were down-double digits ex-China, too, or close to it just in Medical alone because most of the sales, I know, into China today are Medical, right? And they were down only 10%. I say only because I think we thought that would be more like 25%, 30%. So just trying to figure out, is that -- was that some of the weakness in the quarter within that Medical being down a little bit more and the mix? I know you've called out maybe Industrial down as well, but Industrial was actually up 10% year-over-year. I know it was down sequentially, but I'm trying to figure out was Industrial kind of also below you? What was sort of the mix driver? And going forward, it looks like the gross margin this quarter was supposed to be 33% to 34%. Now you're rebounding in revenue, which looks like that's kind of in line with original projections, but your gross margin is still below what you thought Q1 was going to be. So, can you maybe give us a little more color on that, if that makes sense?

Yeah. I can start off with the gross margin first, Larry. So, gross margin, we did see softness in gross margin in Q1, and that was largely driven by unexpected softness in the Industrial segment. Overall, volume in Industrial -- overall volume for the business is quite low at $190 million for the full company. So, there is under absorption in our factories in both Industrial and Medical. So there's lower volume. And then the unfavorable mix in Industrial segment drove gross margins down. And right now, we are seeing that the mix in Industrial in Q2 is also not as strong. And the overall volume is also not where we would like it to be. So, between China and Industrial and the mix on the Industrial is bringing the gross margins down, which we expect to rebound or recover in the second half, and that's what we are expecting right now. And then…

More Industrial than -- it's more of an Industrial -- a mix within Industrial than Medical, it sounds like outside of the--?

In terms of…

Yeah. Right. Okay.

And then could you repeat your first question or the other piece -- the first part of your question.

My other question was just kind of -- and I'll rephrase it, I guess. I think at the start of the year or at the end of the last -- when you kind of gave this 3% to 5% full year revenue down guidance. And I think you had said, if I'm not mistaken, you thought Medical ex-China would be flat to up. Do you still think that?

I think at this point, when it comes to the guide or the outlook around 3% to 5% down, I would say that at this point, we would be more closer to the lower end of the range than the higher end of the range, meaning more between 4% to 5% as opposed to 3% to 4%. So that is there because we were initially expecting a little bit better performance from our Industrial segment. I'm not sure if we really commented on Medical ex-China. China still continues to be a situation. China was a pretty strong growth area for us, but CT and some other products over there. And there -- outside of the two things that we talked about, macroeconomic as well as anticorruption, we expect China to come back. It's just that the timing is somewhat of an unknown factor for us. And the full year will really, Larry, depend upon does China come back at the beginning of Q3? Or does it come back towards the end of Q3, and that will determine the Medical -- overall Medical situation in a big way for us.

Okay. And then just on the Industrial piece. Again, I know you don't actually go by segment, but you had a great year last year. This quarter, like I said, was up 10%, but down somewhat sequentially. And now you're lapping much more difficult comps, too, obviously, as we get even next quarter. Do you still -- but it sounds like -- it sounds a little bit mixed there, too. Do you still think -- certainly, it sounds like you'll grow sequentially or that you're building that into expectations? Do you think you grow in the back half year-over-year? Or does that segment overall -- you did 220 last year. Is that a good place to start for this year? Or do you think you can see that?

Yeah. A little bit of -- a few things going on there. Let me explain that, Larry. So, yes, the comps are going to become -- Industrial, we grew very well last year. We grew 19% year-over-year in 2023. So that's clearly a very strong growth we had last year in Industrial. And yes, you rightly pointed out we did $220 million there. In Industrial, we are seeing kind of like a tale of two cities. And why I say that is this. In industrial, it is still very strong in the cargo inspection area, where we are shipping a lot of hardware or what we call industrial systems or these big linear accelerators or LINACs. When we ship these LINACs, our gross margin on the hardware or the system upon shipment is lower. Our gross margin on the service piece is much higher. So, overall, when you look at our Industrial, we have softness ex-cargo. And within cargo, the distribution between systems and service is a lot more skewed towards systems because right now we are shipping quite a bit of that. So that brings the overall gross margin down for the segment. It's a good thing because it will generate…

Right.

Yeah. Exactly. So that's happening on the Industrial side. In terms of overall volume or sales levels for Industrial, obviously, we would not be able to repeat the percentage growth factor in Industrial of 2023. But we are still hopeful of having a year-over-year growth in Industrial, again, provided the timing when it comes back. The cargo inspection business, we have good visibility for the rest of the year. On the non-cargo industrial business, we need to see how it develops. If it comes back sooner than later, then the overall year will be a growth year for sure. So that is something that we are monitoring, and that's where we are.

And just remind me, the cargo, that's like it includes like security too, that's like one-third of the segment, plus or minus. Is that about right? And then everything else is two-thirds. Am I -- is that right? The ballpark?

So security inspection is around in that range.

For cargo.

Yeah. Sometimes it can go higher, Larry, in certain quarters when we're shipping -- right?

Okay.

Yeah.

Okay. Just last question, just on the photon technology and some being adopted more or maybe not -- it just sounds like we're in the early stages of adoption. And you mentioned one particular OEM. I don't know if you could answer, I guess, a broader question. With this, I guess, to some extent, cannibalize the existing technology? And is this customer a customer today of you guys in your existing technologies?

Larry, before we go to this photon counting related question, I just want to correct that cargo is around 20% of the segment, not 30%.

Okay.

And with that -- yeah. And then on the photon counting, I'll ask Sunny to comment here. But in general -- not in general, specifically what Sunny talked about was photon counting for CT. So that is not a market that we are participating today. So, there is no cannibalization. That's really new market, new business development for us.

Yeah. And Larry and everyone, in general, the photon counting detectors go into a whole new type of applications, where someone needs a flat panel or a large area detector, they will go with a flat panel detector and where they need a different type of performance, particularly in high-speed imaging or a different type of dynamic imaging, they'll use photon county detectors. So, we are not seeing cannibalization or we don't expect cannibalization at this stage between flat panel detectors and photon counting. So that's one thing. So within existing customers, these would be new applications, new products. And then, of course, as Sam said, the CT is a brand new space, new addressable market.

Got it. I appreciate that clarification. Thank you, Sunny, and thank you guys.

Thank you. Our next question comes from the line of Michael Toomey with Jefferies. Please proceed with your question.

Hey, guys. Thanks for taking my questions. Mike Toomey here from Jefferies covering for Xuyang Li. Most of my question has been answered, but just two, please. Can I ask a follow-up on the photon accounting? When do you think that this could start contributing to the revenue for you guys? Are we talking in the next two years or longer term? And anything you'd highlight on either pricing from your side or costs kind of easing or stabilizing, whether that's globally or in China? Thanks for taking my question.

This is Sunny. I didn't catch the second part of the question. So, let me answer the first one.

Sure.

I think cut -- the cost question. We'll come back to that. So, photon counting. So, there's -- there are -- in addition to -- we talked about CT quite a bit about photon counting applications for CT. That is -- that's a longer duration project. Those are -- our typical cycles for these types of projects are three to five-ish type of years more -- and this being a new technology more on the five-year side. However, we've been working with our customers now for about a couple of years. So, we're looking at about a three-year type of horizon for when we expect our CT detectors to start contributing in any measurable volume, so to say. Between now and then we will see some amounts of prototypes and low volumes of shipments. There are other applications within photon counting that are also being contemplated. Those will also be within that two to three-year window, but those are for other modalities. And there you'll see the revenue contribution to be modest. A large chunk of our photon counting detectors are being sold -- a larger proportion of our photon counting detectors are going into industrial for food inspection and other applications, high-speed, real-time imaging applications in industrial. Those are short cycle. Those are happening continuously, and we're counting on industrial to contribute to the growth of photon counting in the near term.

Okay. All right. That's really helpful. And just to reiterate the second question was just if there's anything on price that you're charging, any pressure on pricing and any change -- significant changes in the cost.

At this time, the supply chain driven issues they are largely behind us. I would say that freight is quite manageable at this time. And from the raw material cost perspective, things have begun to normalize or they're rather stabilized at this point. We talked about price increases about 12 to 18 months ago. That round of price increases has largely been completed. And other than on a spot basis, we are not embarking upon any new across-the-board price increase type of a campaign at this point. But we are looking at here and there different situations where we need to work on certain price related initiatives, which we would do. And in case inflation picks up much more than what we are planning, then we would address it through a campaign of price increases. But that is not front and center for the situation at this time.

Okay. Great. Thanks very much.

Thank you. There are no further questions at this time. I'd like to turn the call back over to Chris for closing remarks. End of Q&A:

Great. Thank you. I'll now turn over the call to Sunny for some final comments.

Thank you, Chris. In closing, as always, I'm very proud of all the hard work of our employees globally as they work to support our customers every day. We're looking forward to our customer successes with incorporating our technologies and also looking forward to their success this year with new product launches. So thank you for taking the time to join us today and for your continued interest in Varex.

Thank you, Sunny, and thank you all for your questions and participating in our earnings conference call today. The webcast and supplemental slide presentation will be archived on our website. A replay of the quarterly conference call will be available through February 20th and can be found at vareximaging.com/investorrelations. Thank you, and goodbye.

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