Greetings, and welcome to the Varex Fourth Quarter and Fiscal Year 2023 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce Christopher Belfiore, Director of Investor Relations. Thank you. You may begin.

Good afternoon, and welcome to Varex Imaging Corporation’s earnings conference call for the fourth quarter of fiscal year 2023. 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/news. 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 fourth quarter of fiscal year 2023. In addition, unless otherwise stated, quarterly comparisons are made sequentially from the fourth quarter of fiscal year 2023 to the third quarter of fiscal year 2023 rather than to the same quarter of the prior year. 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 fourth quarter earnings call. I'm pleased to announce another solid quarter for Varex. Revenue of $227 million in the quarter was a result of strong performance in our Industrial segment offset by lower revenue in China in our Medical segment. Non-GAAP gross margin of 36% and non-GAAP earnings per share of $0.45 exceeded our expectations. Revenue in the fourth quarter decreased 2%, both sequentially and year-over-year. Revenue in the Medical segment decreased 7% sequentially and 10% year-over-year, while Industrial segment revenue increased 12% sequentially and 27% year-over-year. Non-GAAP gross margin of 36% was solid in the fourth quarter and above the high end of our expectations. This is primarily due to a beneficial segment and product mix led by higher proportion of Industrial sales as well as further realization of results of our pricing initiatives. Adjusted EBITDA in the fourth quarter were $38 million and non-GAAP EPS was $0.45. We ended the fourth quarter in the fiscal year with $195 million of cash, cash equivalents and marketable securities on the balance sheet, which was $42 million higher sequentially and $82 million from the fiscal 2022 year-end. The increase was primarily due to higher profitability and the reduction of inventory in the quarter and year. Let me give you some insights into sales detail by modality in the quarter compared to a five quarter average, which we refer to as the sales trend. In our Medical segment, global sales of CT tubes remain flat compared to the trend in the quarter as the lower sales in China was offset by strength in the rest of the world. Mammography remains strong with sales above the trend in the quarter. Oncology improved in the quarter was -- and was above…

Thanks, Sunny, and hello, everyone. As a reminder, unless otherwise indicated, I'll provide sequential comparison of our results for the fourth quarter of fiscal year 2023 with those of our third quarter of fiscal 2023. The fourth quarter was another solid quarter for us, while revenue was below the guidance midpoint, gross margin and non-GAAP EPS were above the high end of our guidance. Continued strength in our Industrial segment was the primary driver of strength in the quarter. As a result, we reported sales of $227 million, non-GAAP gross margin of 36% and non-GAAP EPS of $0.45, which was also helped by an unusually low tax rate in the quarter. Cash generation remains strong with $47 million of operating cash flow in the quarter. Fourth quarter revenues decreased 2% compared to the third quarter. Medical revenues were $164 million, and industrial revenues were $64 million. Sequentially. medical sales decreased 7% and industrial sales increased 12%. Medical revenues were 72% and industrial revenues were 28% of total revenues for the quarter. Looking at revenue by region. Americas increased 1% sequentially, while EMEA increased 1% and APAC declined 8%. The decline in APAC was primarily the result of lower sales in our China business due to the anti-corruption campaign there. China sales were 13% of fourth quarter revenues. For full fiscal year 2023, sales to China totaled $147 million, which is up 5% year-over-year and represents 16% of total Varex sales. Given the anti-corruption campaign, we expect China sales to be down in fiscal 2024 compared to fiscal 2023. Visibility to the magnitude and duration of the impact from this campaign is unclear, but we expect this to be temporary and currently believe the market may improve in the second half of our fiscal year 2024. We remain focused on executing…

Thank you. Ladies and gentlemen, at this time, we’ll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of James Sidoti with Sidoti & Company. Please proceed with your question.

Hi, good afternoon. Can you hear me?

Yes. Hello, Jim.

Hi, Jim.

Hi. Thanks for taking the questions. Well, let’s start out with China because I think that’s the thing people are going to focus on most. It sounds like revenue at 16% [ph] of sales was around $36 million in a quarter. Sorry if you said it, but what was it a year ago?

The revenue a year ago in China was just give me one second here, Jim. It was – a year ago, it was – Q4 2022 it was about $37 million, and in Q4 2023 not $36 million, $31 million.

$31 million, okay.

Yes. Yes.

And was the decline primarily related to the anti-corruption or can you break that out?

To what we see, Jim, it is mostly related to anti-corruption measure. But at the same time, we know the economy in China is also soft. But it is very difficult for us to parse out the two issues they might be connected. So – but mostly we would say it is anti-corruption measures based on what we are hearing through our sales channel who have been talking to customers over there.

And in the past when China’s implemented these anti-corruption initiatives and sales have declined, have you seen a rebound relatively quickly in two or three quarters, or how long do you think it takes for the sales to come back based on historical?

So the last time we – I think last time we saw this was somewhere around 2014 timeframe. And as we look at our revenues from 2014 to 2015, it’s – it seemed to have bounced back. It felt fairly quickly bounced back. But at that time, we also had a very small amount of business in China, not nothing like what we have today.

Okay. All right. And then if we move on to the AI, it sounds like you got an application approved for liver surgery. What about applications for things like breast cancer detection or prostate cancer detection? How far are you from some of those projects?

Yes. So our software business has two channels. One where we go through OEMs, so our breast, prostate, those are sold through OEMs. Our lung screening workstation is a standalone workstation full workflow solution that we go direct and that continues on and we’re bidding on tenders as we’ve described previously. And this is also another new standalone solution for, to support liver surgery transplants, et cetera. It’s a direct-to-market channel and that’s why we went for the full 510(k) for this.

Okay. So for the other applications, the OEMs will do the FDA conditions?

Correct. Correct. We also sell lung screening modules and applications through the OEM channel, but we have a full standalone workstation. So our software business in summary has two parts. There’s acquisition and diagnostics. And the acquisition is our – what we call as our Nexus platform. It’s a combination of tube detectors, integration with generators. It’s a full blown acquisition system that we sell also through the OEM channel. Those are mostly through systems integrators. And then the pure AI software historically was sold through the OEMs. Over the last few years, we’ve started going directly to bidding directly on tenders and selling directly to hospitals.

All right. And then on the industrial business, I mean, another very strong quarter. What’s driving that and are these growth rates sustainable?

So we had an exceptionally strong fourth quarter for industrial, which was more than actually what we had forecasted. The strength was broad based. We saw it in many of the non-destructive inspection verticals as well as cargo was as we said, it was a bright spot this quarter. We expect for the year, we expect industrial to still grow. So we’re going to have a growth year for industrial, but the first quarter will be down and it will be down because of actually a lot of strength in the fourth quarter. So there tends to be monthly puts and takes and we had some customers that were up against some deadlines and pushed us very hard to ship some additional products, which is what we did in the fourth quarter. And so we’re going to have a – we’re going to see a softer first quarter, but overall for the full fiscal year, we’re expecting a growth out of industrial year-over-year growth.

Okay. All right. Well, yes, so it seems like big picture, the margins are getting better. The industrial business continues to grow and you have a short-term hiccup in China. But long term you still think China is going to be a growing market for you, is that correct?

Yes. Absolutely. We believe so. The Chinese government continues to assert their commitment to expansion of healthcare. We’re very well positioned there. Our installed base is large and keeps growing. We are making a lot of advances with products with our Chinese OEM customers in cardiovascular and some of the – some additional modalities like dental, et cetera. So China continues to be a good market for us. We’re well positioned for 2025. We just need to get past this current malaise. And so we’re anticipating that the second half of next year is when that’s what we’re hearing where the recovery will begin.

And then the last question from me on the balance sheet. I know you have some debt paydowns coming up. What’s your plan for capital allocation? Are you going to continue to build up the cash balance so you can pay down some of that debt or do you think you’ll be more active on the acquisition front in the next four or five quarters?

Yes, Jim, so yes our overall cash balance at the end of Q4 was $195 million. And I just want to remind looking at the balance sheet, you may not be able to get to that because it’s distributed amongst couple of lines, but the total cash was $195 million and we clearly are in an excess cash situation. But as you rightly said, we are essentially preparing for upcoming refinancing because the debt is supposed to mature in June of 2025, but it would go current in June of 2024. So essentially, we are building up the cash balance to approach refinancing with strength and at the same time take care of some of the excess cash situation. At this time, priority is to – from a capital deployment perspective, the priority is to fully fund the operations and then followed by deleveraging. And lastly, and then beyond that would be an inorganic growth.

Okay. All right. Well, thank you. Thank you for taking the questions.

Thank you, Jim.

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

Go ahead, Larry.

Thank you, and hey, good evening guys. I guess first question just on the medical weakness on revenue, is it sounds like you guys are feel like it’s mostly China, whether it’s economic-related or mostly the – just the increased scrutiny in this – in the anti-corruption environment, but anything on – just on the U.S. side of it. And I’ve seen a lot of hospital-based companies just having issues with hospital spending budgets. I know you being a little bit tight obviously hospitals aren’t doing well in a high interest rate environment either. And I know you guys in 2023, I think we started out good, then we got a little bit more – a little more conservative and then less in Q3 things were a lot better. So any – but it feels like you haven’t spoken too much about negatives there, but I’m just trying to connect those dots. Thanks.

Let me make a comment my last time to chime in. So there were many puts and takes Larry. First of all, first quarter is a seasonally lower quarter. And secondly, the situation in China put it – puts additional burden on the medical side. So that, that is what’s driving the – pressure on the medical in the first quarter. And then of course, then compounding the fact that industrial had a strong fourth quarter and we’re just seeing a month-to-month kind of a issue there. In terms of the U.S. and the hospital market, our general perception and what we’re hearing and seeing is that the hospital’s – health of the hospitals is improving. They’re reporting better operating expenses controls. So we think that they’re in a better position going forward into the next year to for capital deployment. So no real concerns there. What we want to make – what we we’re trying to get our head around is how and when the Chinese situation will turn around.

Yes. Larry, I would add that if you look at our Q4 results, revenues in Americas improved sequentially over third quarter, and then EMEA also improved over the third quarter. The place where you typically would want to see a growth, but it declined in fourth quarter was APAC. And we talked about China driving that. So Americas and EMEA, they both grew and the impact was through China reflected in APAC. And from Q4 into Q1, there’s a seasonality that is coming in and we then expect to resume the growth from there in Americas, EMEA, et cetera. And then the China, as we’ve already talked about, it is somewhat of a situation dependent. And my – as and when this anti-corruption campaign gets over, we hope to begin to grow from there in that region.

And specifically China, and I know you’re not guiding, as you look at the 2025, but it feels like the next few quarters, it’s hard to time exactly when the shakes out. But any concern, I mean, that when as we get back to normalization that we’re at a lower level, it feels like I know the – there’s been any change in sort of that mid to longer-term outlook for the build out of CT in China. Anything there of significance?

Larry, nothing particular. First of all, if you – if based on the anecdotal and customer feedback, we think what’s been happening over the last several months is a significant reduction in new system placements. So that means the volume of business that we’re getting from China has been primarily grew. China for us is mostly tubes and mostly CT tubes. So the business that – the volume of business that we’ve been seeing has been replacement tubes to keep their hospitals and healthcare systems running.

Right, right, right.

So that we think is a good baseline for us. So from here on, as business comes back, there is going to be some amount of pent-up demand, which will adjust the levels back up, and then we expect it to grow back from there. Now we’ve grown – China business has grown at 20% plus per year. We don’t – and we’ve said before that that is not sustainable. We expect growth to come to what would be kind of secular levels for China, which is in the 8% to 10% type of a range. So that’s what we think will happen. It’ll bounce back, there’ll be a little bit of pent-up demand, which will raise the baseline and then go back to a little bit more traditional growth rates.

Larry…

Right. Okay. I know you’re not guiding – yes, yes, I’m here. Yes, sorry.

No, go ahead, Larry. Go ahead, please.

No. I was just going to say, I just I know you’re not guiding, sorry to interrupt. I know you’re not guiding on the revenue line specifically, but just from a high level, if you decline 4% at the mid-point, right? If I just – if the rest of your business is flat and China’s down 25%, you’d be, you’ll decline 4%. That’s just the way the math works out, like almost to a key [ph]. So my – again, it sounds like the rest of your business might actually be up. So it feels like China could actually be down more than 25% in front and bigger in the beginning of the year. Am I thinking about that kind of right?

Larry, we are not guiding by geography or anything, but in some ways you are thinking in a right way. We are expecting China full year to be a down year for 2024. In terms of percentages, et cetera, we are not guiding. But broadly, you are thinking about it right. Yes.

Okay. Okay. And I interrupted you. I don’t know, were you trying to say something before that? I’m sorry about that.

I was trying to say something Larry, but now I forgot what your question was.

That’s okay. All right. I’ll move on. I’ll let someone else get into the queue. Thank you, guys.

Sure. Yes.

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

Sam, Sunny, can you hear me all right?

Yes. Hello, Suraj.

Yes.

Good afternoon, gentlemen. So Sunny, did I hear you all correctly that the expectation of the anti-corruption wave to abate is roughly around two quarters? Or did I get that wrong?

We’re expecting that we will start to see things pick up again in our beginning of our third quarter. So that’s again the situation is little fluid. We will know better in the upcoming months, but the current expectation is that mar – in Q3 – beginning of Q3 onwards, we would start to see it pick back up.

Got it. Sam, I know there are a lot of moving parts, appreciate that. But to the extent that China contribution is soft, does it necessarily now should we start looking at gross margin? There should be an uptick.

Yes, so that's right, Suraj. China, lack of China revenues or less proportion of China revenues is actually a tailwind for the gross margin. But we also need to keep in mind, the volume effect of it. So the two aspects intersect, but part of the reason Q4 gross margin were much higher than our expectation is because China mix went lower than what we were expecting at the beginning of the quarter. So your intuition is right there that less China revenue does help gross margin, but only to the extent that the volume is not – lack of volume is not becoming the driving factor.

Got it. Sunny, in terms of tubes and detector manufacturing in India, is this strategy local for local or local for international?

No. India is going to be first local for global and then later also local for local. So the India strategy is an extent is slightly different from that of China, in this case, we're setting India up as a full capability operating center. So full manufacturing for extending our capacity from Salt Lake to India and then also business functions, R&D, et cetera. So India's going to become a full blown hub for us for South Asia.

Got it. Got it. Final question, Sam, and I'll hop back in queue. So Sam, since the time that I've picked up Varex, I think so almost three years ago to now just ballparking it. Okay. Industrials has gone from almost 20% contribution to, let's say, around 30% contribution, right, to overall sales. Obviously, there are respective growth rates in these two buckets. As we look forward over, let's say, the next four, eight quarters, is this a trajectory that we should continue to expect, i.e., increasing contribution of industrials and that's really how we should start thinking about the overall business. Or do you think like to steal Sunny's words that some temporary malaise, but then it should revert back to the 80/20? Gentlemen, thank you for taking my questions.

Yes. Suraj, very good question. In general, Industrial business growth rate for us is higher than the Medical business growth rate. So I expect the overall contribution of Industrial segment to our revenues to continue to climb. And in the next three to five years, it might cross 30%. So that is the right way to think about it. There are just a lot of applications that we are seeing that X-ray technology can be very successfully applied in for the Industrial business. So right now, we are thinking that eventually Industrial could go 30% or somewhat even higher than that in terms of the overall revenue proportion.

Thank you.

Thanks, Suraj.

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

Thanks and good afternoon. Maybe just to segue back to China, Sunny you mentioned, it's – tubes are still sort of trending well here, but it's been a slowdown on the capital front. But I just want to confirm, we've heard actually both headwinds throughout the quarter due to anti-corruption, meaning that procedures were down through the third quarter, but also that capital purchases slowed down. So I know you mentioned tubes were still trending well, has there been any slowdown in tubes? And do you expect actually tubes can also see a catch up once things normalize into next year? And I'll have one follow-up.

Let me clarify. Tubes has been down. So that's what's led China to the decline in sales for us. However, when we ask our customers, where are these going? It's – we are not sensing a strong placement of new systems. So our understanding is this is mostly going into replacement and wherever there might have been a smaller percentage of those than normal for new systems. So hard for us to tease this apart. But the general sense is that new business or new systems, placements is down and replacements have continued, but tubes overall have been down as a result.

That's helpful. And then maybe just when you think about the global manufacturing footprint, new disclosure tonight on India, how does that play with Wuxi is? Is Wuxi only going to exclusively supply to China? Will India supply to India? What happens to Salt Lake over time? Or will India and Wuxi become just larger global hubs? Thanks again.

Yes. So China and Wuxi was – our footprint in Wuxi was set up for China. So we optimized it for the specific products that are – were needed in China. And to the extent, particularly for detectors, the detectors that we make in China, we've also been shipping to other places where we needed lower cost detectors. So from that perspective, Wuxi is mainly for China. India, the capacity that we're adding to India actually moves out some capacity from Salt Lake, frees up Salt Lake for some other products. Salt Lake is running the tubes. Production at Salt Lake is running at very high capacity levels. So this frees up space here. And then the production in India is initially intended, Phase 1 is intended for global sales. And these will be at a lower cost with lower cost supply chain over the last three years during the COVID phase, and since then we have been diversifying our supplier base and one of the things we did was qualified a lot of suppliers in India. So this is – this gives us access to lower cost supply chain, lower manufacturing costs, and makes us more competitive. That's the intention. And then for many of the newer tubes, the innovation and some of the high end tubes, we will use up the capacity freed up in Salt Lake for that.

Thanks again.

Thanks, Anthony.

There are no further questions in the queue. I'd like to hand the call back to management for closing remarks.

Great. Thank you for your questions. Sunny, do you have any final comments?

Yes. It's a short comment. Thanks, Chris. So in closing, we're really pleased with the results we achieved in fiscal 2023. And as always, I'd really like to thank our employees all over the world for their efforts during this – during the year. Everyone worked really hard to contribute to our results. And 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 participating in our earnings conference call for the fourth quarter of fiscal year 2023. The webcast and supplemental slide presentation will be archived on our website. A replay of this quarterly conference call will be available through November 28 and can be accessed at vareximaging.com/investorrelations. Thank you and have a great evening.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.