Welcome to the Varex Imaging Earnings Conference Call for the Second Quarter of Fiscal Year 2017. [Operator Instructions] As a reminder, this conference is being recorded. At this time, I would like to turn the call over to Mr. Howard Goldman, Director of Investor Relations and Public Relations. Thank you. Mr. Goldman, you may begin.

Good afternoon, and welcome to the Varex Imaging Corporation's conference call for the second quarter of fiscal year 2017. With me today are Sunny Sanyal, our President and CEO and Clarence Verhoef, our CFO. To simplify our discussion, unless otherwise stated, all references to the quarter or year are fiscal years and fiscal quarters. Quarterly comparisons are for the second quarter of fiscal 2017 versus the second quarter of fiscal 2016, unless otherwise stated. Comparable financial statements for fiscal year 2016 and the first quarter of fiscal year 2017 reflect operating results for the Imaging Components business of Varian prior to its separation, and include estimates of cost allocations for various corporate functions, interest expense and tax expense. Please be advised that this discussion contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Our use of words and phrases such as believe, estimate, expect, anticipate, intend, could, should, will, opportunity, prospect, potential, continue, outlook and similar expressions are intended to identify those statements which represent our current judgments on future performance or other future matters. While we believe them to be reasonably based on information currently available to us, these are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those anticipated. Risks relating to our business are described in our second quarter earnings release and in our filings with the SEC. The information in this discussion speaks of as of today's date and we see assume no obligation to update or revise the forward-looking statements in this discussion because of new information, future events or otherwise. And now I'll turn the call over to Sunny.

Thank you, Howard. Good afternoon, and welcome to our first earnings conference call since becoming a new public company. As you know, at the end of January this year, we completed the spinoff from our former parent company, Varian Medical Systems. Our common stock began trading on NASDAQ on January 30, under the symbol VREX. A tremendous amount of effort went into making our separation a huge success in such a short period of time. I would like to thank all Varex and Varian employees who worked together tirelessly to make this happen without disrupting our customers. A lot of exciting things have happened since the separation. Most notably, on Monday, we announced that we completed the acquisition of PerkinElmer's Medical Imaging business. I'd like to first provide a summary of our quarterly financial results and then come back to highlight these exciting items. Top line growth was 3% for the quarter and 5% year-to-date. Since the slowdown in our revenues in the second half of 2015 and the first half of 2016, all of our product lines have experienced good recovery and the trailing 12-month revenue growth rate was 7%. Our net earnings increased to $15 million or $0.40 per diluted share. Our gross margin was 37% in the second quarter and our operating margin was 15%, both down from the prior year quarter due to a shift in product mix and higher cost of quality. We were encouraged to see lower SG&A costs in the second quarter. This was a 27% sequential improvement from the first quarter of this year, which included allocations from Varian and separation costs. In a few minutes, Clarence will discuss our financial results in greater detail. But before that, let me give you some color on the market segments that we serve and…

Thanks, Sunny, and hello, everyone. As Sunny mentioned, this quarter was a huge milestone for us as we completed the separation from Varian and are now able to provide you with a good look at Varex as a stand-alone company. Given the separation costs that are in our first quarter's operating expenses, the year-to-date information that we are providing will only be for revenues and gross margins. Our second quarter revenues were up 3% to $155 million from $150 million a year ago. Year-to-date revenues were up 5% to $312 million, with good performance in most all of our product offerings. Medical segment revenues increased 3% in the second quarter to $126 million. Year-to-date, revenues were up 5% to $257 million and represented 82% of our business. The primary modalities where we saw good growth were CT, mammography, dental and general radiography. Industrial segment revenues for the second quarter increased 6% to $29 million. The major driver of this growth was in our security products, where we saw a nice increase in linear accelerator revenues and the related service business. This was partially offset by a decline in industrial detectors sales. Year-to-date revenues were also up 6% to $55 million. Our company-wide gross margin was $58 million in the second quarter, down from $59 million in the year-ago quarter. As a percentage of revenue, the gross margin was 37% compared to 39% a year ago. The change in gross margin was primarily due to higher cost of quality as well as a product mix shift to lower-margin radiographic components. These items were partially offset by increased sales of higher-margin linear accelerators for security applications. For the first half of the year, our gross margin was 37% compared to 39% in the prior year. While we now expect the full fiscal…

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

Sunny, this is your first call as a separate component company, maybe you could just take a step back and sort of discuss -- obviously, you participate in very competitive markets in general. But maybe you could sort of discuss the competitive nature of your two primary markets or the one market broken into two between tubes and flat panel, and sort of the dichotomy between the higher end and the lower end there.

Sure. Thanks for the question, Larry. So as you said, the two biggest chunks of our revenues come from flat-panel detectors and x-ray tubes. And the competitive dynamics are very different in these two markets. In both these product lines, there is -- there are high-end products and, I'd say, value segment or low-end products. And they're -- it's all -- I'll give your reference to both of those. So let's start with X-ray tubes. The high-end -- when we talk about high-end X-ray tubes, these are typically our CT tubes. And then the low-end side, these are radiographic tubes. And the dynamics there are the higher-end tubes are more difficult to manufacture and are more expensive. The low-end tubes, the radiographic tubes, are cheaper and generally easier to manufacture. So you can imagine from a competitive standpoint, there are many more players that manufacture tubes on the radiographic side. And actually, no -- there's no independent manufacturer of CT tubes. So in the X-ray tube business, we largely compete with OEMs themselves. So our biggest competitor is the in-house capabilities that the top three manufacturers have. Now what's happened over the years is the number of manufacturers have increased, but the people that can make the high-end -- the CT X-ray tubes are still limited to your GE, Siemens, Phillips, Toshiba as the manufacturing OEMs. On the radiographic side, there's a couple of other companies that make those tubes. Now in terms of -- the basic dynamics of the tubes business are we ship new tubes, there's a very large portion of our revenues, about 80% of the tubes revenues come from replacement market which is the replacement tubes, tubes that finance life cycles. The CT tubes, while they are most expensive and the highest-priced tubes, they're also request…

Okay. No, that was very helpful. And just one follow-up question on that, and as it refers more to the current quarter and the last two quarters. You mentioned pricing has sort of stabilized in the last couple of quarters or last couple of years. Gross margin, obviously seems to be sort of at the low end of, I think, longer-term targets, has come down in the last couple of years. It sounds like it's not from pricing, what is it from? And is that something that you can sort of turnaround or at least stabilize?

But great question, why don't I ask Clarence to take this.

Yes. So Larry, the gross margin is driven by two factors, I would say. First of all, the first one is it's a lot about of the mix of what we're selling. So we are going to have variation from quarter-to-quarter. So for example, we talked about the large order that we took and fulfilled for the -- the tender-based order to ship several hundred radiographic systems and package of systems. Those were lower-tier products. The radiographic systems, it's also the more basic X-ray tubes and the radiographic detectors. So that had an impact on our gross margins in the quarter. And the second is that -- the factor that comes into play is pricing does come into play. I would say that we have seen very good cost-reduction efforts now taking effect where the cost reductions we're seeing and the product costs are offsetting the increases that -- or the decreases that we see because of price erosion, particularly on the detector side. Maybe a little bit of color around that. What I've seen on the detectors in the last year, when I look at pricing, how I look at this is I compare pricing this quarter compared to what it was a year ago for [ light ] products and we have had about 7% erosion or decline in prices for year-over-year comparison. In the dynamic space, the kind of the higher-end products that Sunny was just mentioning, it's low single-digit kind of erosion; while still in the radiographic space, you're going to be in the -- probably the low double-digit kind of range. So that is the offsetting factor that we have.

Our next question comes from Paul Coster with JPMorgan.

I do apologize, I've got a few questions. So first of all, welcome to the market. It's good to have you out there. So first off, Clarence, you mentioned at the end of your prepared remarks that pro forma reporting will commence soon. What are you going to do? Are you going to just start stripping out FAS 123 and amortization expense? Can you just kind of talk us through why you've mentioned that?

Yes. So if you think about, okay, what are the primary reasons why you go to a non-GAAP reporting, it's really trying to adjust onetime items out of there so you got an apples-to-apples comparison. Obviously, the biggest one that we have is the impact going on with the acquisition. And so the items that would be adjusted for it's going to be amortization of intangibles, the acquisition-related costs. And then in the longer term, if there was any impairments that were done or any restructuring costs, those are the kinds of onetime events that would get adjusted. I would say that we're going to approach this very conservatively, that we will not be doing anything such as, you just mentioned the FAS 123R, which is a stock-based compensation. We will not be doing any -- an adjustment for something like that, because that's considered an ongoing operational expense.

Got it. Okay. When you announced the PerkinElmer acquisition, I think you also noted that there was a couple of things to be resolved. There were some regulatory approval -- I assume, it's done, but also a couple of customer contract assignments. Can you update us on that, please?

Well, just the good news is, is they're all done, otherwise we wouldn't have been able to actually close the transaction. So the primary one was getting the government antitrust approvals, and that was U.S. and Germany. That took a little bit of time, but it did go through in the first round of the process, I guess, as such. And then there was also some contractual items that needed to be done that we all got completed in the month of April.

Got it. Okay, my last question is on the Toshiba rollover. If you think about the value of the contract over the period of time, does the margin improved insofar as its price for sort of a cost end state at the beginning of the rollout, where initially it's less profitable near the end? Or is -- does it work in a different way from that?

So Paul, I guess, I -- because it's specifically around the CT X-ray tubes, which is a space where we have got very stable pricing and very stable margins in that space. You're not going to see a lot of movement happening around that. I think as we continue to do things that are cost-reduction activities inside of our process of manufacturing, those are the opportunities that we have to gain some margin there. And then I think the other side of it is that we have -- for a few of the tubes in particular, we have built in some structure in the agreements where if the life of the tubes or the performance of the tube improves, then we actually have some price adjustments accordingly. And so that kind of an event is a profit-sharing kind of arrangement between us and Toshiba. So that would be a margin improvement as well.

And our final question comes from John Koller with Oppenheimer.

It's Oppenheimer + Close. Quick question on the quality issues that were discussed. Just wondering if you could give, more broadly, whether that was tube or panel, and what specifically or broadly that might be? And then when do you expect to get that under control?

John, so this is Sunny. We're a very vertically integrated manufacturing environment on the tube side and so we have a lot of process steps, a lot of materials that come in, raw materials that get converted into, then finally the finished goods goes through a lot of processing steps. So it's not uncommon for us to have some variability in the production environment. And the typical things that impact our costs are stuff like scrap, rework. So this quarter -- and by the way, this variability that's quarter-over-quarter. So this particular quarter, we have some more-than-expected scrap on the tube side and as a result of that, you get -- when you have that, you also end up with the rework, which results in slightly higher labor costs. So that was nature of this increased cost of quality. These are typically one-off events. Nothing here that we see as recurring. So we expect to continue to be back in line with our normal performance as we proceed through this quarter and next quarter.

Okay. Great. And then just as a follow-up, I was wondering if you can roughly break out, in Medical, the difference between percentage-wise and sales between tubes and panels.

So the -- a little bit of at a rough level, but it's the x-ray sources, tubes plus linear accelerators is going to be in the 45% to 50% kind of range or probably closer to 45%, and the detectors are going to be in the 40% of 45% range in our current scale. So obviously that changes quite a bit when we add in the PerkinElmer detector business, because that will then change that mix a bit, quite a bit. Because the $140 million that gets added for PerkinElmer is entirely detectors.

There are no further questions at this time. I would like to turn the call back over to Mr. Goldman for closing remarks.

Well, thank you for of questions and participating in our earnings conference call for the second quarter of 2017. A replay of this quarterly teleconference will be available from May 4 through May 18 and could be accessed at Varex's website or by calling 1 (877) 660-6853 from anywhere in the U.S., or 1 (201) 612-7415 from non-U.S. locations. The passcode for these replays is 13660264. Goodbye.

Thank you. This concludes today's teleconference, you may disconnect the line's at this time. Thank you for your participation, and have a wonderful day.