Varex Imaging Corporation

Greetings. Welcome to the VARICS 2Q FY21 earnings call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. I will now turn the conference over to your host, Howard Goldman, Director of Investor Relations. Howard, you may begin.

Good afternoon and welcome to Verix Imaging Corporation's earnings conference call for the second quarter of fiscal year 2021. 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 Verix's website at investors.veriximaging.com. The webcast and supplemental slide presentation will be archived on Verix's website. To simplify our discussion, unless otherwise stated, all references to the quarter are for the second quarter of fiscal year 2021. In addition, unless otherwise stated, quarterly comparisons are made sequentially from the second quarter of fiscal year 2021 to the first quarter of fiscal year 2021, rather than to the same quarter of the prior year. 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 risk and uncertainty 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 SEP 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 statement in this discussion. On today's call, we will discuss certain non-GAAP financial measures. These non-GAAP financial 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. And now I'll turn the call over to Sonny. Thank you, Howard. Good afternoon everyone and welcome. I'm pleased to report that our financial results for the second quarter were stronger than our expectations and revenue exceeded pre-COVID levels. Continued strong global CT tube sales and higher sales of industrial digital detectors drove this growth. Demand for our other medical imaging products related to certain elective medical procedures also increased. Our revenues in the second quarter increased 15% sequentially due to gains in both medical and industrial segments. Revenues increased 3% year-over-year. Our non-GAAP gross margins increased to 35% due to higher volume and a favorable product mix. Our non-GAAP operating expense declined sequentially and year-over-year, reflecting benefits from previous cost reduction actions. our non-GAAP operating margin improved to 13% of revenues. As a result, non-GAAP EPS was $0.35 and exceeded the top end of our guidance range. Next, let me give you some high-level insight into how our different modalities and applications trended during the quarter. Medical segment revenues increased 13% sequentially and 1% year over year. Momentum in CT tube cells, which has been building over a number of quarters, remained strong in Q2. Many of these tubes were for new systems, which are also expected to result in future sales of replacement tubes. In our other medical modalities, oncology, mammography, and radiography also saw growth, while fluoroscopy and dental remained flat. We believe this growth is due to demand that had been deferred over the past year as well as from expansion of healthcare services in some markets. Revenues in our industrial segment increased 24% sequentially and 13% year-over-year. In Q2, demand for digital detectors for non-destructive inspections increased across several of our industrial verticals. However, demand for imaging products for security screening at ports and borders, as well as baggage screening at airports, continued to lag. Now I'd like to take a few minutes to highlight the great work we're doing in our X-ray tubes business. In future, I'll highlight other areas of our business in the same way. Demand for new CT systems in China and upgrades of CT systems globally are driving growth in our tubes business. In China, we believe demand is likely to grow at approximately 10% a year for the next several years due to increased installations at fever clinics, and a focus on making rural health systems more self-reliant. Our strategy in China has been to establish relationships with local OEMs. I'm happy to say that of the initial 12 CT projects we have been working on with eight local OEMs, nine projects have been brought to market and three are still in process. We believe that local Chinese OEMs have made very good progress and currently account for approximately 40% of CT sales in China. Based on our experience, new OEMs tend to initially focus on gaining market share through launching entry-level systems. This has occurred in China for the CT modality. We are now seeing that the local OEMs are ready to expand into 64, 128, and higher slice CT system projects in order to provide greater diagnostic imaging capabilities, including systems that are needed for cardiac procedures. These projects are potential future opportunities for us, and the relationships that we have built with these OEMs over the past five years will play a significant role in our continued success in the China CT market. As part of our Local for Local strategy, our Wuxi facility continued to scale up loading of extra tubes for the China market. By loading tubes, we mean assembling the X-ray tube inner core into locally sourced housings for OEM's specific customizations and final testing before shipping to our customers. Over the past year, while most of our customers maintained momentum with their current R&D projects, many of them have slowed down their commitments to new R&D projects while they assessed the market situation. During the quarter, we saw an increase in momentum in new product development activity within our customer base across their X-ray imaging product lines, which we interpret as a reflection of their confidence in the markets that they serve. Our own R&D activity, on the other hand, did not slow down. Later this fiscal year, we plan to introduce two new CT tubes specifically for high-end 256 and 320 slice CT systems. During the quarter, our software business received FDA 510K clearance for an enhanced version of our CT lung screening application, which uses artificial intelligence for automated detection of suspicious nodules. And at the same time, during the past few quarters, we have continued to make progress with our investments in innovation focused on nanotube technology. Now I'd like to share some additional details about this exciting new technology being developed through our joint venture, VEC Imaging. For simplicity, throughout this nanotube discussion, my use of the word our refers to our joint venture, where we own 50%. First, let me start by outlining the differences between conventional x-ray tubes that use thermionic filament technology and our cold cathode nanotube technology. On the left-hand side of the slide, you will see that conventional x-ray tubes require an electric power source to heat up a filament. Operating temperatures can get up to 2,400 degrees Celsius. In addition, the ability to place conventional emission sources close to each other is limited, a term that we call packing density. In contrast, our nanotube technology uses a localized electric field to extract electrons from solid-state emitters. This technology operates at room temperature and has very high switching speeds. Due to its form factor and high packing density, our nanotube technology enables us to design X-ray tubes where many emitters can be sequentially arranged and turned on or off at high speeds. These multi-beam X-ray tubes can offer increased design flexibility to build lighter, mechanically simpler, and more compact imaging systems. We believe that our nanotube technology will provide many benefits over conventional X-ray sources. First and foremost, we believe that systems designed using nanotube-based X-ray sources will significantly lower the total cost of ownership for hospitals and imaging centers. For example, in a CT application, a lower TCO could be realized by eliminating the very heavy rotating gantry along with numerous interconnected parts, pieces, and components that are needed to support the complex mechanical design. These electromechanical components add cost, complexity and weight and requires significant downtime and expenses to maintain, repair, and replace over the life of the system. In contrast, systems designed using our nanotube technology could have very few, if any, moving parts and would be much simpler in design, have a significantly smaller footprint, and weigh much less. This simplicity is expected to result in lower maintenance costs and significantly reduced system downtime In addition, the next generation systems would be smaller, lighter, and portable, and could give healthcare organizations additional flexibility in their care delivery process. We believe the combination of our nanotube technology and Verix's multi-decade long experience with designing and manufacturing X-ray sources will enable our customers to redefine medical imaging in the coming years. To give you a status update, our R&D efforts with nanotube technology is progressing well. X-ray sources are characterized by energy, emission, and a few other parameters. We have achieved our intended energy output of 40 to 180 kilovolts at different emission levels measured in milliamps. We are now conducting accelerated life testing of different configurations of tubes. While life testing is ongoing, to date we have completed over one billion projections per emitter at 160 kilovolts. We believe this is the equivalent of several years of emitter life for a typical CT application. We are encouraged by these results and are continuing to move forward with our product development efforts. With that, let me hand over the call to Sam.

Thanks, Sunny, and hello, everyone. Before getting to our numbers, I would like to acknowledge that on March 31st, our audit committee appointed Deloitte as our new external auditor. There were no disagreements with our prior auditors on any matter of accounting principles or practices, financial statement disclosures, or auditing scope or procedures. We look forward to working with Deloitte. As a reminder, unless otherwise indicated, I will provide sequential comparison of our results for the second quarter of fiscal year 2021 with those of our first quarter of fiscal 21. RAREX delivered excellent results for the quarter, driven by broad-based strengthening of our business across both of our segments. For the quarter, both revenue and non-GAAP earnings per share were above the top end of the guidance range. Second quarter revenues were $204 million, a sequential increase of 15% from the first quarter. Medical revenues were $157 million, and industrial revenues were $47 million. This translated to 77% medical and 23% industrial sales. Sequentially, medical sales grew 13%, while industrial sales saw a strong 24% growth. On a regional basis, all three areas saw robust sequential growth. Americas grew 15% overall, with higher growth in the industrial segment. EMEA grew 17%, while APAC grew 14%. Let me now cover our results on a GAAP basis. Second quarter gross margin was 32% and flat sequentially with the previous quarter. Operating expenses were down $2 million compared to the first quarter and interest expenses were $10 million. Earnings per diluted share were $0.08 compared to a loss of $0.16 in the prior quarter. Moving on to non-GAAP results for the quarter. Gross margin was 35%, a sequential improvement of 100 basis points from the first quarter, driven by higher sales volume and a favorable product mix. Freight and logistics costs ran high, and we expect them to remain high until the ocean freight-related delays and uncertainties subside and the air freight volume normalizes. I want to remind you that our gross margin can fluctuate from quarter to quarter due to segment mix between medical and industrial, product mix within each segment, customer concentration, cost performance, and factory utilization levels driven by sales volume. Our gross margin has improved sequentially from 28% in the last quarter of fiscal 20 to 34% in Q1 and now to 35% in Q2. This performance is due to increase in sales volume, favorable mix, and through our initiatives to improve efficiencies in our manufacturing and servicing activities. R&D spending in the second quarter was $18 million on 9% of revenues. R&D was 41% of operating expenses in Q2 as compared to 37% in Q1, reflecting our spending prioritization towards innovation and new products. SG&A was $26 million in Q2 as compared to $29 million in the prior quarter. As a result, operating expenses were $45 million and down approximately $1 million sequentially due to a decline in SG&A offset by increase in R&D. We have kept operating expenses in control while successfully meeting increased customer demand in these challenging times, leading to a significant improvement in product sales in the last six months. Overall, our strategy to deliver higher earnings through improved operating leverage is on track and working well. Operating earnings increased significantly to $26 million or 13% of revenue as compared to $14 million or 8% of revenue in the previous quarter. Tax expense in the second quarter was less than $1 million as compared to $2 million in the previous quarter. During Q2, we had two large favorable items in taxes that drove a $2 million benefit and resulted in an unusually low tax expense for Q2. One item was related to German taxes, and the other was related to the Netherlands R&D tax credits. As a result, there was a one-time benefit to EPS of $0.06 per share in Q2. Net earnings more than quadrupled from Q1 to $14 million or $0.35 per diluted share. This compares to net earnings of $3 million or $0.08 per diluted share in Q1. Now turning to the balance sheet. Accounts receivables increased by $8 million due to higher sales. However, our collection efforts were efficient with DSO down by four days to 58 days. Our efforts to reduce inventory materialized in Q2 with inventory down by a healthy $22 million. This is a priority for us, and as a reminder, we are targeting a total inventory reduction of $25 to $30 million during the current fiscal year. For the first half, we have brought inventory down by about $24 million. Accounts payables decreased by $16 million to minimize supply chain uncertainties and improve efficiencies of our overall operations. As a result, days payables dropped to 34 days. Now moving to debt and cash flow information. Cash flow from operations improved to $13 million. While no interest-related coupon payment was due in Q2, we did pay $9 million in taxes in Germany for fiscal year 17 through 20. We ended the quarter with cash of $111 million on the balance sheet, an increase of $6 million in the quarter. Gross debt outstanding was $512 million, and debt net of cash came down to $401 million, reflecting our priority to continue to delever on a net debt basis. Adjusted EBITDA was $33 million in the second quarter, a significant improvement from $22 million in the prior quarter. I'm pleased to note that if you were to annualize our first half fiscal 21 EBITDA performance, the net debt leverage ratio at the end of Q2 would be 3.7 times. This reflects excellent progress towards our goal of a leverage ratio of three times. In summary, our previously stated financial strategy of improving capital leverage and operating leverage is working well. I want to take a moment to thank our RADx colleagues worldwide for their tremendous efforts to enable these results in such challenging times. Now moving on to our business outlook for Q3. Demand environment continues to remain strong for us and allows us to provide the following guidance for Q3. Revenues between 195 to $215 million and non-GAAP earnings per diluted share between 15 and 35 cents. Our expectations are based on non-GAAP gross margin in a range of 33 to 35% and non-GAAP operating expenses in a range of 44 to $45 million. With that, we will now open the call for your questions.