Varex Imaging Corporation (NASDAQ:VREX) Q4 2022 Earnings Call Transcript

Varex Imaging Corporation (NASDAQ:VREX) Q4 2022 Earnings Call Transcript November 15, 2022

Varex Imaging Corporation beats earnings expectations. Reported EPS is $0.42, expectations were $0.36.

Operator: Hello and welcome to the Varex Fourth Quarter Fiscal Year 2022 Earnings Call. At this time, all participants are in listen-only mode. As a reminder, this conference is being recorded. It’s now my pleasure to turn the call over to Christopher Belfiore, Director of Investor Relations. Please, go ahead.

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Christopher Belfiore: Good afternoon and welcome to Varex Imaging Corporation’s earnings conference call for the Fourth Quarter of Fiscal year 2022. 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 2022. In addition, unless otherwise stated, quarterly comparisons are made sequentially from the fourth quarter of fiscal year 2022 to the third quarter of fiscal year 2022, 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.

Sunny Sanyal: Thank you, Chris, and good afternoon, everyone. I’m pleased to announce a strong finish to another fiscal year with revenues reaching $231 million in the quarter, a new quarterly record for Varex. Global demand for our products were solid during the quarter and a slowly improving supply chain and our supplier diversification efforts allowed us to convert more orders to sales. As we start a new fiscal year, I feel good about Varex’s prospects to grow, despite a high degree of uncertainty in the upcoming year. Revenue in the fourth quarter increased 8% sequentially and 2% year-over-year. Revenue in Medical increased 9% sequentially, while Industrial revenue increased 6%. Non-GAAP gross margin in the quarter was 33%, at the low end of our expectations, primarily due to high semiconductor procurement costs.

Adjusted EBITDA was $36 million and non-GAAP EPS was $0.42. Our cash position, including marketable securities was solid at $113 million at the end of the quarter, up $3 million sequentially. Let me give you some high-level insights into the market environment based on qualitative assessment of demand for different modalities and applications during the quarter. Medical segment revenues increased 9% sequentially and were flat year-over-year. Global demand for CT tubes remained solid, but we saw some softness in Asia Pacific, as some customers experienced delays with their other suppliers. Demand across our other medical modalities was solid, led by fluoroscopy, radiography, dental and mammography. Oncology shipments were soft in the quarter, primarily due to timing of shipments to one customer.

Revenues in our Industrial segment increased 5% sequentially and 9% year-over-year. During the quarter we saw broad-based demand across various non-destructive inspection applications, including high energy sources for cargo screening at ports and borders. In the past, we have highlighted various products across our medical and industrial segments that we expect to drive future growth. Today, I wanted to take some time to reflect on the progress that we have made over the last year on these products as well as other fronts and our expectations moving forward. The Global CT market remains a significant driver of sales for Varex. This includes new system installations as well as demand for replacement tubes from our growing installed base. During fiscal 2022, we had several new design wins with our CT customers, including local OEMs in China.

These new design wins represent future sales opportunities as well as 10 to 15 years of subsequent demand for replacement tubes. We continue to expect China to be a key driver of growth for both CT and Varex, as our local OEM partners continue to gain market share. Turning to nanotubes, to further expand our position in nanotubes, in September we entered into technology collaboration with Micro-X, a leader in carbon nanotube based X-ray systems for medical and security markets. This includes an exclusive global license enabling Varex to use Micro-X’s Technology in the field of multi-beam X-ray tubes. Varex believes in the future importance of cold cathode X-ray sources and we’re excited to invest in additional nanotube technology to diversify our product portfolio.

Earlier this year, we highlighted our high-performance X-ray tubes used for cardiovascular applications. During the year, we continued to ship samples of our new Liquid Metal Bearing based CT and cardiovascular tubes for evaluation by potential customers. Over the upcoming quarters, we expect to receive additional feedback on the products and move towards being included in their future system designs. These tubes offer a long-life, noise-free operation and increased throughput for certain applications. Moving to detectors, we were happy to see that our Dynamic Detector platform called Azure continues to receive high interest from our customers. In fiscal 2022, a number of customers began to design Azure detectors into their systems and we continue to receive positive feedback.

We expect to see further adoption of our Azure platform, as our customers launch their product offerings. We have converted the majority of our radiographic customers to our LUMEN detectors. This is a highly competitive radiographic detector platform targeted at the low-end of the market where we have historically had lower market share. We will be showcasing our current LUMEN detectors as well as a new detector for advanced radiographic applications, at RSNA later this November. We also continue to make progress with our Photon Counting technology on both, Medical and Industrial side. In Medical, our Photon Counting detectors are being used in various applications. Further, we’re making progress with our CT customers and are working closely with them to firm up design specifications for integration into their systems.

As we have noted in the past, we do not have an offering in the CT detector market space today, making this an entirely incremental market for Varex. Finally, we have been working to establish a local presence in India. We took a similar approach in China, where we have seen our revenue grow to nearly $140 million in fiscal 2022. We believe, India and Southeast Asia region, will be on a similar growth trajectory and this investment in India will establish a new local presence in the region. Later this month, along with many of our customers, we will be attending the Radiological Society of North America, RSNA Conference in Chicago. Varex will be highlighting its product portfolio including some of the products we have talked about today. Turning to Industrial, we expect the cargo security market for ports and borders to continue to be strong end market for Varex Industrial.

Our security business is experiencing growth as a result of increased demand worldwide for cargo screening systems and our partnership with established OEMs in this space. We expect to see continued growth here, as we head into fiscal 2023, building on the success we saw this past year. Our industrial customers continued to praise the high frame rate imaging capability of Photon Counting detectors and as a result we are seeing increased adoption across various non-destructive inspection applications such as electronics, battery and food inspection. These Photon Counting detectors enable faster inspection rates and better image quality through, enhanced material discrimination compared to other technologies and thus enable factories to meet increased demand in these growth industries.

Last quarter, we highlighted an exciting area within our industrial market. Specifically, I’m referring to the use of X-ray or e-beam technologies to sterilize consumer-facing products. This is not a new market outside of Varex, but one that we have historically had limited exposure to. We expect irradiation to be a growing market in which our high-power X-ray sources can be used to irradiate food and other consumer-facing products. These solutions are in development and introduction stages but we expect to have more details in fiscal 2023, as we receive feedback from our customers. At the recent American Society for Nondestructive Testing Conference, ASNT held in Nashville during early November, our OEM systems integration partners indicated strong backlog and future demand for their inspection solutions in the aerospace, defense and automotive markets.

Our customers see value in our ability to integrate new technologies like Photon Counting Detectors, supporting system components, image acquisition workflow software and AI capabilities for automated inspection. We continue to be excited about the prospect of providing more integrated solutions to our industrial customers. We expect this new approach to be a key growth driver for Varex across several industrial verticals. As we move into a new fiscal year, we’re happy with the progress that we have made with supply chain initiatives and look forward to our prospects in fiscal 2023 and beyond. With that let me hand over the call to Sam.

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Sam Maheshwari: Thanks, Sunny and hello, everyone. As a reminder, unless otherwise indicated, I will provide sequential comparison of our results for the fourth quarter of fiscal year 2022 with those of our third quarter of fiscal 2022. We are pleased with our ability to grow both revenues and earnings this year, despite supply chain challenges that constrained our sales and inflationary pressure from raw materials and logistics that compressed our gross margins. Revenues for the year grew 5% year-over-year to $859 million and non-GAAP EPS grew 9% to $1.43 for the year. Adjusted EBITDA increased 5% year-over-year to $140 million and we finished the year with cash and securities of $113 million. Turning now to the fourth quarter.

Our supply chain initiatives enabled us to ship more in the quarter leading to sales of $231 million above the midpoint of guidance. Non-GAAP gross margin was 33%. Non-GAAP EPS was near the top of our guidance at $0.42. Fourth quarter revenues increased 8%, compared to the third quarter. Medical revenues were $181 million and Industrial revenues were $50 million. Sequentially, Medical sales increased 9% and Industrial sales increased 6%. Medical revenues were 78% and Industrial revenues were 22% of our total revenues for the quarter. Looking at revenue by region. Americas increased 26% sequentially, while EMEA increased 5% and APAC declined 4%. The increase in the Americas was primarily driven by sales into our radiographic and fluoro markets while the decline in APAC was primarily the result of some softness in CT as customers saw delays with their other suppliers.

Sales to China finished the year strong at approximately $140 million in revenue or 16% of total Varex sales. Let me now cover our results on a GAAP basis. Fourth quarter gross margin was 32%, down 200 basis points from the previous quarter. Operating expenses held steady at $50 million and operating income was $25 million, up $2 million sequentially. Net earnings were $13 million and GAAP EPS was $0.32 based on fully diluted 41 million shares. Moving on to non-GAAP results for the quarter. Gross margin of 33% was down 200 basis points from the previous quarter and at the low end of our guidance. There were two primary drivers of the lower gross margin. First, higher semiconductor-related material costs which we expect to continue through fiscal 2023.

And second, our industrial business mix was somewhat unfavorable. R&D spending in the fourth quarter was $20 million flat, compared to the prior quarter and represented 9% of revenue. SG&A was $27 million also flat compared to the prior quarter and represented 12% of revenue. As a result, operating expenses were $47 million in line with the prior quarter and represented 20% of revenue. Operating income was $29 million and operating margin was 13% of revenue, similar to the previous quarter. Tax expense in the fourth quarter was $4 million or 17% of pretax income compared to $6 million or 29% in the previous quarter. The lower tax rate in the fourth quarter was primarily the result of favorable US tax items and international valuation allowances.

Net earnings were $17 million or $0.42 per diluted share, up $0.05 from the third quarter. Average diluted shares for the quarter on a non-GAAP basis were $40 million. Please note that ASU 2020-06, related to the accounting for convertible instruments became effective for us from Q1 of fiscal 2023 onwards. Under this accounting standard, the EPS calculation adds back the after-tax, convertible loan interest expense to net income and add shares underlying our convertible notes and associated bond hedge to the diluted shares outstanding. For Varex, on an annual basis, we add back approximately $6 million of after-tax interest expense to net income and approximately eight million shares to otherwise outstanding diluted shares. For an illustrative view on potential scenarios, please see the appendix of our Q4 earnings slide deck.

Now, turning to the balance sheet. Accounts receivable increased by $16 million and DSO increased one day to 68 days in the quarter, primarily due to higher sales in the second half of the quarter. Inventory increased modestly by $3 million as we target to improve inventory turns, while balancing supply chain risk. As a result, days of inventory decreased to 176 days. Accounts payable decreased by $5 million. Now, moving to debt and cash flow information. Cash flow from operations was $17 million in the fourth quarter and we ended the quarter with cash and securities of $113 million, an increase of $3 million from the prior quarter. Gross debt outstanding at the end of the quarter was $450 million and debt, net of $113 million of cash and securities was $337 million.

Adjusted EBITDA for the quarter was $36 million and adjusted EBITDA margin was 16% of sales. Our net debt leverage ratio was 2.4 times at quarter end. Now, moving to outlook for Q1 of ’23. We see demand patterns running higher than pre-COVID levels, but lower than what we experienced six months ago. Given our strong backlog and supply chain initiatives, we expect to grow sales in fiscal 2023 over ’22. However, we expect inflation driven higher material and labor costs to keep our gross margin around the 33% level. Moving to guidance for the first quarter of fiscal ’23. As a reminder, the first fiscal quarter is generally a seasonally low quarter for shipments for us. With that in mind, our guidance for the first quarter is as follows. Revenues are expected between $195 million and $215 million.

At the midpoint of $205 million, this is up 3% from Q1 of fiscal ’22; and non-GAAP earnings per diluted share are expected between $0.10 and $0.30. Our expectations are based on non-GAAP gross margin of about 33%, non-GAAP operating expenses in the range of $46 million to $47 million, tax rate of about 28% to 30% for Q1 and fiscal 2023 non-GAAP diluted share count of about 41 million shares. Please see slide 22 with the title illustrative impact of ASU 2020-06 in our earnings presentation for more details on the various scenarios for non-GAAP diluted shares under this accounting standard. With that, we will now open the call for your questions.

Q&A Session

Operator: Thank you. We will now be conducting a question-and-answer session. Our first question today is coming from Larry Solow from CJS. Your line is now live.

Larry Solow: Great. Thanks. Just to clarify, just on the guidance real fast for the — I know you only give one quarter guidance in light of the new convertible tax flow accounting rules. It’s essentially €“ for Q1, you’re still assuming the 41 million shares. So, it’s essentially only the lack of add-back of that interest expense, right, that non-cash interest expense. Is that correct just for Q1?

Sam Maheshwari: Yeah. So Larry, this is Sam. Good to talk to you. The way this accounting standard works, it makes EPS calculation a little bit more complicated. But what happens on a non-GAAP basis, if you’re moderately saying say less than $0.21, $0.22 you’re still using 41 million shares for the diluted share count. But if you are looking at more than $9 million in non-GAAP net income or say about more than $0.21, $0.22 then you’ll add back $1.4 million of interest expense, which is after tax interest expense to the numerator, and then add eight million shares to the denominator. So, essentially beyond $0.21, $0.22 of non-GAAP diluted EPS, you are mentally assuming, as if the convertible has converted. So you no longer have to pay the interest expense. And then the share count goes up by $8 million. So, that’s the way to think about it. I hope that, clears for you or €“

Larry Solow: Yeah. So €“ no, it does I guess. And I looked at some of your charts, I’m just trying to simplify it, because I don’t get, how it kind of skews up. So your guidance is kind of then €“ it’s kind of taking in a range of those scenarios.

Sam Maheshwari: Yeah. So our guidance is $0.10 to $0.30, as we just guided. So, towards the higher end of that guidance, between say $0.22 and $0.30 it would go towards the scenario, where we add back the interest expense and add the dilutive shares and below $0.21, $0.22 we are not.

Larry Solow: So, like in theory, hypothetically, if you just on an operating basis reach the high end of your operating profit right, which would in theory put you at the high end of your operating EPS, assuming nothing else changes, you’re actually impacting yourself on a quarter-to-quarter basis that’s like an $0.08 sequential difference, right? Because you’re adding back the $0.03 of interest expense, and like $0.05, $0.06 of €“ you’re adding €“ your share count is increasing 20%, right? So that’s simple math. That’s on $0.30 that’s $0.06 right? And then €“

Sam Maheshwari: Yeah, Larry on an annual basis €“

Larry Solow: I’m just trying to make it simple. These charge €“ you can look at €“ they don’t do anything. They’re just €“ I know you put them up there, but there’s so many numbers. I’m just trying to make it simple. So, on a high-end scenario, your guidance could have been $0.38, isn’t that right $0.39?

Sam Maheshwari: That’s a little bit high, Larry €“ yeah, that’s a little bit high, Larry. This guidance

Larry Solow: But close to that, right? Directionally, I feel like that’s right, right? I mean €“ or let’s ask it this way. If you had the impact in Q4 of this eight million shares and you couldn’t add back the interest expense, you would have done $0.50 €“ you would have done $0.34 correct? $0.33 or $0.32.

Sam Maheshwari: No, the impact is about $0.04 a quarter, Larry, because the numerator is a positive thing and the denominator is a negative thing that.

Larry Solow: Okay. So you’re taking away the €“ you’re taking, yeah. Okay.

Sam Maheshwari: Yeah, so annualized impact is $0.12, $0.13, $0.14 in that range. So for a given quarter, it’s about $0.03 to $0.04.