Varex Imaging Corp Q1 FY2023 Earnings Call

Greetings and welcome to the Varex First Quarter Fiscal Year 2023 Earnings Call. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation. 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, Christopher. You may begin.

Good afternoon and welcome to Varex Imaging Corporation's earnings conference call for the first 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 presentations 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 2023. In addition, unless otherwise stated, quarterly comparisons are made sequentially from the first quarter of fiscal year 2023 to the fourth quarter of fiscal year 2022. Finally, all references to the year are to the fiscal year and not the 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 suitable substitute for GAAP financial measures. We provide 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.

Thank you, Chris, and good afternoon, everyone. We are pleased to report sales of $206 million for the first quarter consistent with our expectations. This was a result of a more balanced operating environment, driven by good demand, and improved supply chain and our internal supply chain initiatives. That said, while demand levels were as expected, product mix was less favorable in the quarter and as a result, gross margin was lower than what we had originally anticipated. With that, let's discuss our results for the quarter. Revenue in the first quarter was down 11% sequentially, but up 3% year-over-year. Revenue in the Medical segment declined 12% sequentially, while the Industrial segment revenue declined 9%. Non-GAAP gross margin in the first quarter was 32%, which was below our expectation, due to a shift in our product sales mix to mid and lower-tier products during the quarter. Sam will talk more to this during his prepared remarks. Adjusted EBITDA in the first quarter was $25 million and non-GAAP EPS was $0.21. We ended the quarter with $108 million of cash, cash equivalents and marketable securities on the balance sheet, down $5 million from $113 million in the prior quarter, this was primarily due to higher inventory in the quarter. Now let me give you some high-level insights into the market environment based on an assessment of demand that we are seeing for different modalities and applications. Medical segment revenues increased 3% year-over-year and decreased 12% sequentially. Across our product portfolio, we believe our customers are exhibiting cautiousness as they assess an uncertain economic environment ahead. Many of them are still facing challenges fulfilling their backlog, primarily due to material shortages. As a result, demand globally for CT tubes was soft, while demand in other medical modalities including fluoroscopy, oncology, and mammography was flat to down. Demand for dental and radiographic products was stable to up. Revenues in our Industrial segment increased 5% year-over-year and declined 9% sequentially. Demand for industrial tubes and detectors remained strong in the quarter, led by strength across non-destructive inspection products. Security markets continued to slowly improve as our customers converted their prior period tender wins into orders for us at a higher rate. Throughout Varex’s history, we have focused on investment in R&D and innovation in the field of X-ray imaging. We see the X-ray based imaging industry continuing to evolve and as long-term component supplier to imaging OEMs, we are at the center of this evolution. This is very evident as we met with our customers at RSNA this year. As you may know, each November, we attend the Annual Radiological Society of North America Conference in Chicago. This is the largest radiology trade show of the year and is well attended by both our OEM customers and our peers. With over 31,000 participants in attendance, this conference provides us a significant opportunity to take the pulse of the markets we participate in. This year, RSNA was a very meaningful event for Varex as our customers returned to the show with a pre-COVID level presence and enthusiasm. Specifically, we saw a significant shift from conversations centered around supply chain woes to active conversations around new product development and our role as a component supplier to them for these future products. Photon counting technology stood out as a key highlight of our discussions at the conference with many customers interested in our technology and how it could be integrated into their new products. The focus was mainly on performance, resolution, image quality of photon counting technology, as well as dose reduction and spectral imaging capabilities. We believe there is a significant opportunity with our photon counting technology for both medical and industrial applications and we continue to make progress with our CT customers for potential integration into their systems. With regard to some of our other detector products, customers continue to show a high level of interest in our dynamic detector platform called Azure. A number of our customers are already using this platform across various modalities and we expect continued integration given the level of interest we saw. Our radiographic customers remain excited about our LUMEN detectors, which continue to gain interest. LUMEN is a highly competitive radiographic detector platform currently targeted at the approximately $400 million segment of the radiographic market where we have low market share. We are excited about the LUMEN family of detectors and are working on a number of projects in 2023. While AI software has been part of our RSNA in the past, it felt more palpable this year with a very large exhibit footprint dedicated to this technology. A key area of interest was AI software related to lung screening. As we have highlighted in the past, we believe our AI-aided lung cancer screening software Veolity will benefit from a global focus on proactive lung screening. Last year, we installed six Veolity platforms in various locations in British Columbia. All of these systems are working well and have provided runway to be involved with a tender process in Manitoba. In Ontario, we have a test installation that could also lead to a tender process. The conversations with current and prospective customers support our view for the continued evolution of the X-ray industry towards new technologies. While some of these products are several years from being commercialized, there is no doubt that the industry is evolving into a higher technology arena in line with where we have dedicated R&D dollars. With over 70 years of expertise in the imaging industry and strong customer relationships, we are a critical player in making this evolution a reality. Turning back to the quarter, while demand in the first quarter was per our expectation, as we start the second quarter, we're seeing a softer demand environment. We expect this change in market dynamic to lead to revenues that will be flat to slightly up for the year. Further, we expect the less favorable product mix we experienced in the first quarter to continue into the second quarter.

Thanks, Sunny, and hello everyone. As a reminder, unless otherwise indicated, I'll provide a sequential comparison of our results for the first quarter of fiscal 2023 with those of our fourth quarter of fiscal 2022. In the first quarter, demand and supply came in balance. As a result, we are reporting sales of $206 million at the midpoint of our guidance. Non-GAAP gross margin was 32% below our expectations, primarily due to lower margin product mix. Non-GAAP EPS was $0.21. First quarter revenues were down 11%, compared to the seasonally high fourth quarter of fiscal '22. Medical revenues were $160 million and industrial revenues were $46 million. Medical revenues were 78% and industrial revenues were 22% of our total revenues for the quarter. Looking at revenue by region, Americas decreased 7% sequentially, while EMEA decreased 13% and APAC decreased 14%. This was against a seasonally strong fourth quarter. Sales to China were 17% of our overall revenue for the quarter. Let me now cover our results on a GAAP basis. First quarter gross margin was 31%, 100 basis points lower than the prior quarter. Operating expenses were $50 million flat, compared to the fourth quarter of fiscal '22 and operating income was $13 million, down $12 million. Net earnings were $3 million and GAAP EPS was $0.08 based on fully diluted 41 million shares. Moving on to the non-GAAP results for the quarter. Gross margin of 32% was down 100 basis points sequentially driven primarily by low margin product mix. While demand in the quarter was in line with our expectations of a product mix in the medical segment changed. We saw reduced sales of higher margin, higher-end CT tube and certain detector products. In the Industrial segment, we saw lower service revenue, which typically carries a higher margin profile. This product mix shift caused approximately 100 basis points of margin compression in the quarter, compared to the fourth quarter. We believe some customers are taking a more cautious stance either due to the macroeconomic environment or challenges fulfilling their backlog due to supply chain shortages. R&D spending in the first quarter was $20 million flat, compared to the prior quarter. It was 10% of revenues at the high-end of our targeted 8% to 10% range, due to seasonally low sales level in Q1. SG&A was approximately $27 million flat compared to the prior quarter as a result, G&A was 13% of revenue. Operating expenses were $47 million or 23% of revenue, which was flat sequentially. Operating income was $18 million, down $11 million sequentially, due primarily to the lower gross margin. Operating margin was 9% of revenue, compared to 13% in the fourth quarter of fiscal 2022. Tax expense in the first quarter was $2 million or 15% of pretax income, compared to $4 million or 17% in the fourth quarter of fiscal 2022. We are now modeling a 25% tax rate for the full fiscal year 2023 due to certain tax reform related favorable items, as well as increasing R&D and foreign tax credits. Net earnings were $8 million or $0.21 per diluted share, down $0.22 sequentially. Average diluted shares for the quarter on a non-GAAP basis were $41 million. Now turning on to the balance sheet. Accounts receivable decreased by $15 million from the prior quarter due to lower sales in the quarter, compared to the prior quarter and DSO increased two days to 70 days. Inventory increased $17 million in the first quarter. As a result of this, days of inventory increased to 203 days. While it is common for our inventory to increase in our first fiscal quarter, we expect inventory to decrease going forward. Accounts payable increased by $8 million and days payable was 55 days. Now moving to debt and cash flow information. Net cash flow from operations was a use of $4 million in the first quarter, due to an increase in inventory, employee incentive payments and the biannual coupon payment on our debt. We ended the quarter with cash, cash equivalents and marketable securities of $108 million, a decrease of $5 million from the fourth quarter of fiscal 2022. Gross debt outstanding at the end of the quarter was $450 million and debt net of $108 million of cash and marketable securities was $342 million. Adjusted EBITDA for the quarter was $25 million and adjusted EBITDA margin was 12% of sales. Our net debt leverage ratio was 2.5 times at quarter end. Now moving on to guidance for the second quarter. As we talked about earlier, we are providing an outlook for revenue in fiscal 2023 to be flat to slightly up compared to the prior year. Separately, we believe hospitals are seeing good patient and elective procedure volume. However, higher in capital expenditures and long-term payback projects are being reevaluated. This phenomenon is cascading over to us as a somewhat unfavorable product mix. As a result for the second quarter of fiscal year 2023, revenues are expected between $205 million and $225 million and non-GAAP earnings per diluted share are expected between $0.05 and $0.25. Non-GAAP earnings guidance includes an anticipated $2 million payment for technology transfer milestones in R&D. This would equate to approximately $0.04 in non-GAAP EPS. Our expectations are based on non-GAAP gross margin in a range of 31% to 32%, non-GAAP operating expenses in a range of $48 million to $49 million, temporarily high due to the anticipated R&D milestone payments. Tax rate of about 25% for the second quarter and the rest of fiscal year 2023 and non-GAAP diluted share count of about 41 million shares. With that, we will now open the call for your questions.

Thank you. We will now be conducting a question-and-answer session. Thank you. Our first question is from Young Li with Jefferies. Please proceed with your question.

All right, great. Hey, everyone. Thanks for taking our questions. Can you hear me alright?

Yes, we can hear you alright, Young.

All right, perfect. I guess maybe just to start on the cautiousness from customers' comments. I was wondering if you can expand upon that a little bit more, which products, end markets, and geographies are more impacted? And what's holding up better? I mean, it sounds like some of your customers are maybe seeing some more deferrals or cancellations as well?

Hey, this is Sunny. The cautiousness comes from just the general conversations that we've had with customers and the actual softening in order intake rates of the call offs as we call them that we're seeing from them. Without exception, every conversation that we've had with our customers, they've indicated to us that they're sitting on a backlog of work-in-progress that they can't get out of the door, because they're missing some components in their systems that they're building. These are not in our tubes or detectors; these are other parts and components that they're missing. So that's causing them to rebalance some of their inventory and enhance the orders to us. Now that's what's driven us to look at our forecast for the rest of the year, and we've indicated that we're seeing some softening.

All right, great. Very helpful. I guess maybe one more on I guess, the China market is attractive and important. I guess, what are you seeing and hearing on the ground related to the COVID disruptions during the quarter? And how has that changed, if any, in January? And how long do you think that market might take to sort of normalize?

Li, what we're seeing in China, first of all, with COVID, there was disruption across the board for most of our customers. They're having trouble getting people to work and getting products out the door. So there is somewhat of a similar situation as I described earlier with being unable to get products out of the door, but in their case, it was a lot of it was also tied to labor. We managed to deliver all the things that were needed. In terms of CT, our strength in China is heavily based on CT, and we are doing well with CT. There's been a lot of CT buying and although the Chinese government continues to reinforce their investment in healthcare. This year, we expect that there'll be some softening in demand going down from the traditional high buying to more traditional growth rates. So again, early signs, early indicators, there's no sign of slowing down of overall investments in healthcare and CT buying we expect will continue. For us, it's a two-pronged matter: one is new sockets that we get through a lot of these activities. By the way, there has been continued activity with R&D and new design wins as the Chinese OEMs continue to bring out new models. So one prong is new sockets and the second prong is we've now sold quite a bit of new sockets into China. We expect their replacement revenue stream from that to continue and should help us in the future.

All right, great. Appreciate the color. I'll get back in queue.

Thank you. Our next question is from Larry Solow with CJS Securities. Please proceed with your question.

Great. Thanks and good afternoon or good evening. Just following up just on the demand or the questions on the somewhat lower, at least from a high level of the revenue outlook. It seems like it's a combination of things. I guess it's some supply chain issues that are continuing and you mentioned just things caught up in the work-in-progress. But I guess also the hospital spending over capital expenditure sort of reassessment. That seems to be somewhat of a newer phenomenon, I guess. How does that flow to the OEM like, are there orders? It sounds like the OEM orders are still good, so I'm just trying to figure out does this hospital slowdown? Is that like a next step? Does that maybe make this slowdown a little bit longer? Just trying to kind of connect the dots there.

So, hi, Larry. This is Sam. Yes, so what we are hearing from hospitals and the CEOs, what they're saying is that although they are seeing very good patient volume and elective procedure volume. And as you know from prior history, we are connected to the hospital CapEx somewhat, particularly to the elective procedure volume overall. They're saying is that they are under tremendous profit pressure, so to say, in the sense their expenses are running quite high. In order to maintain their profits, they are looking at everything. And this is what we've heard more from the United States-based hospitals. And as they look at it, they're scrutinizing their capital expenditures and also everywhere that they can manage their expenses better. In this scenario, what we are hearing is that longer-term ROI type of projects which are much higher in terms of capital layout. Those are probably being deferred or delayed. Anything that can increase patient volume, et cetera, is already being taken care of. So we believe that is causing a little bit of push-out on the higher-end products or higher-end machines, and that is cascading over to us. That's what we believe is happening over there. Of course, we are one step removed, but that's what we mean.

It seems that end market demand is heavily influenced by patient volumes, which are essential for your long-term business. However, customer behavior can change, leading to decisions like investing less in CT machines for the future, which makes it difficult to predict trends over just a few quarters. Regarding China, I am looking for more clarity. I believe China is still behind in their CT machine expansion initiative, which I thought was gaining momentum in 2020. I'm curious about what factors might be slowing this development, as it doesn't appear to be catching up as quickly as expected. I'm seeking additional insights on this matter.

Yes, if you look at our growth in China, that's been at a very high clip, 20%, 30%-ish type of growth in terms of the buying. So this month is holiday month in China. There's New Year, so hard to call it a trend. But in general, we're not seeing a slowing of government investment. We're not seeing a slowing in the expansion of healthcare. So the question becomes how long is it going to continue at 30%-plus pace? That's the part that I think as we look ahead, we can see a couple of quarters. We can't see beyond that, but we're just putting it in that same bucket of the softening to same. CT continues to be strong, and right behind CT in China is cardiovascular and oncology. Those are the newer modalities that are starting to pop up. So overall, prospects of China for us continue to remain strong.

Okay, that's fair. I understand that a growth rate of 30% or 40% cannot be sustained indefinitely. However, sales are still increasing. Could you clarify the impact of COVID-related shutdowns in the fourth quarter? I know from discussions with other manufacturers that this quarter typically involves accelerated manufacturing and overtime due to the anticipated slowdown during the Chinese New Year. It seems like a double challenge. Still, it appears that your company hasn't been significantly affected by the COVID shutdowns. The CT build-out over the past few years occurred even during the peak of COVID. Did this factor in any way into your results for this quarter or your outlook for the next quarter?

Yes. The medical products were exempted throughout that process. There was some disruption, but it was not significant. We continued production over the past several quarters. It did not have a major impact on us, and we do not expect the reopening to significantly increase our operations either, as it really did not affect us in that way. Our operations during this period remained stable alongside our customers.

If I could just ask one more question about revenue slowing. It seems like inflation still affected your labor costs, which isn't ideal, but hopefully that's improving. I'm trying to understand if there are any strategies you can implement. You've done a good job in the past couple of years managing costs in a challenging environment. So if the revenue outlook is a bit slower, are there any offsets you could consider over the next few quarters, or is there not much that can be done in that regard?

Yes, there are certain levers we can consider, but each comes with its own timeline. Currently, the cost increases are impacting our profit and loss statement sooner than we can realize any price improvements, which creates a drag on our results. This currently accounts for a 200 basis point hit. In the December quarter, we experienced high freight costs that have started to improve since January, which previously impacted our gross margin by about 100 basis points. We anticipate that freight will continue to improve in the coming months. We've also discussed our product mix, which I hope will be a temporary issue that primarily affects us in the first half of the year, with improvements expected in the second half. The mix is challenging to predict or manage and is currently impacting us by about 100 basis points. As we work on enhancing our gross margins and overall financial performance, we are focused on improving manufacturing efficiencies. The pressure on our supply chain has been gradually easing over the past few months, and as it continues to improve, our manufacturing efficiency should also benefit. We still expect revenues to remain flat or slightly increase, although this outlook may not be as strong as we initially projected a few months ago. The improvements we anticipate will stem from enhanced manufacturing efficiencies and hopefully a stabilization in our product mix over time. I'm optimistic that as quarters pass, the impact of the price-cost drag and high-cost components will diminish as they cycle through our inventory.

Okay. And I appreciate that color. That's great. Thanks again, guys.

Thank you.

Thank you. Our next question is from Suraj Kalia with Oppenheimer. Please proceed with your question.

Sunny, Sam, can you hear me alright?

Yes, we can, Suraj. How are you?

Hope you guys are well. Sunny, Sam, you've provided a lot of insights about the future outlook. Sunny, I'd like to compare and contrast a specific point. GE Healthcare has shared a very optimistic forecast regarding cash spending, imaging, and sound across the board. As I recall, they didn't express the same level of caution. Your contracts are largely forward-looking, and a significant part of your revenue is recurring. Can you help clarify this? On one side, there's caution from your end, while on the other, some larger companies seem to be very aggressive. What are we missing in this situation?

I'll start and then Sam can elaborate. Our OEM partners have slightly different order and delivery schedules compared to ours. Recently, they experienced strong bookings, but if they currently have inventory that's unshipped, which includes our components, it impacts us. Thus, our current quarter may be slower because of their reduced output. As their work in progress moves through the system, we anticipate some order progress and call-offs in the upcoming quarters. For Q2, we expect ongoing softness since our OEMs are working through their inventories. As they clear this backlog, we expect to see better progress throughout the year. With this in mind, we analyzed our revenue run rates, and that led us to conclude that we are more likely to see flat or slight growth instead of significant growth, especially as activity tends to increase in the latter half of the year. In the current recessionary climate, we've heard from customers that they are facing challenges in scheduling deliveries for larger products. Smaller items are making their way through the capital budgeting process and reaching customers, but anything needing facility modifications is being pushed back due to capital expenditure constraints and other priorities. Given this situation, we are trying to form a picture of the future, aware that our visibility is limited to about two quarters. As we look further ahead, we are proceeding with caution.

I would also like to add that my understanding is that our customers are experiencing a backlog of six to twelve months, while we have a backlog of four to six months. This backlog serves as a buffer, allowing our customers to deliver to their customers. In contrast, with less than two quarters of backlog, we see the impact a bit sooner. This illustrates one key difference between us and our customers.

Got it. And Sam, specifically for you, I'll hop back into queue after this. You made some comments in terms of the gross margins. Obviously, they came a little softer than our expectations. Maybe I missed it, Sam. Was there any shift in customer credit terms, DSOs? Any additional line-item color would be greatly appreciated. Gentlemen, thank you for taking my questions.

Thank you, Suraj. There hasn’t been any significant change regarding customer credit or DSO. DSO increased by a day or two, but overall it has remained stable. Currently, the credit issues are not a concern. As I mentioned, our gross margin fell short of expectations, primarily due to the mix. The mix can vary and is difficult for us to predict. It was this mix that led to the gross margin being lower than we anticipated. We are guiding for Q2 with a similar somewhat unfavorable mix. We believe that the mix should improve after Q2, which is our current perspective.

Thank you. Our next question is from Anthony Petrone with Mizuho Group. Please proceed with your question.

Oh, apologies. Line was muted. Good afternoon, Sunny and Sam. Maybe just staying on the theme here, the outlook. And to really splice it a little bit finer geographically. It sounds like it is broad-based? In other words, that you're seeing similar sort of trends, whether it be in Europe and the U.S. specifically and maybe a little bit better as it relates to trends in China, although they're currently going through COVID in the current quarter. So maybe just to fine-tune it a little geographically, are the headwinds that you're hearing from customers more acute in the U.S.? Are they more acute in Europe? How are they faring in China? And then I have a follow-up.

Sure. Anthony, it feels fairly broad-based, I would say. The variability right now we see is more by modality. Modalities like dental, we did see strength in dental, the fluoroscopy and oncology in these other mid-tier modalities. The non-CT modalities, they're flat to down. These are pretty heavy modalities that have high price points and require a lot of work. By the way, for those, our customers are in all regions of the world. Then CT felt soft, and not as much by geography. I don't know if that helps to answer your questions more by modality. China is experiencing their strength, which is probably just a cyclical thing or just a consumption issue tied into some level of softness, but we're not expecting anything dramatically different there.

And then maybe more near-term in the first half, some of the chip companies and AMD and Intel called out just some lingering headwinds in 1Q, but that toward the back half of the year, the outlook for chips improves a bit. I mean, should we expect some of the pressure as you relate to your full-year guidance to be more front-end loaded instead of back-end loaded?

Yes, just one quick comment. We tend to be about 90 to 120 days ahead of everyone else ahead of OEMs, right? Because of where we sit in the supply chain process. If the OEMs end up clearing up their whip backlog that they're currently stuck on, then things will start to open up for us in the second half. But again, that's a bit unknown because you can only see six months or so.

Yes, Anthony, I can provide some information regarding your question related to costs and the pricing perspectives of Intel and AMD. When we procure chips, not just FPGAs but all types, we typically plan many years in advance, ranging from 12 to 24 months, and sometimes even longer. As the chip situation improves, our procurement in the second half should be more favorable. However, currently, the inventory we hold consists of high-cost chips, which I mentioned earlier in response to Young's question. Most of these high-cost chips should be cleared from inventory by the end of this calendar year. This is our current situation, but any positive developments from Intel, AMD, and others will certainly benefit us in the future.

Thank you very much. I'll get back in queue. Thank you.

Thanks, Anthony.

Our next question is from Jim Sidoti with Sidoti & Company. Please proceed with your question.

Hi, good afternoon. Thanks for taking the questions. First one on inventory, the increase in inventory, I guess two questions, why now? And now that you have inventories at this level, are you confident that you won't have any stock out issues for the remainder of the year? Do you have all the key components you need for fiscal 2023?

Yes, Jim. There are a couple of reasons for the increase in inventory, which has been rising for several quarters now. At the beginning of Q1, we were anticipating a higher growth rate and positioned our inventory accordingly. Moving forward, we will adjust it to align with our revised forecasts. I want to emphasize that Q1 is typically a seasonally low revenue quarter for us, largely due to demand-supply factors, and currently, demand and supply are relatively balanced. The Q1 results reflect the demand levels we experienced. From an inventory management standpoint, we aim for stability. Historically, our inventory has grown by about $20 million in the past four to five years, so a growth of $17 million is not unexpected. I acknowledge that inventory levels were somewhat high, and we were targeting higher revenue, so we will be making adjustments. We expect inventory to decrease partly due to these adjustments, but also as we anticipate revenue growth, with the midpoint of our guidance being higher than actual Q1 revenue. All these factors should contribute to reducing inventory in the future. That's an overview of the inventory situation. I hope that answers your question, Jim.

Okay. Yes, yes. And then following up on that, so I would assume and you'll see positive cash flow from operations for the remainder of the year as you start to work down that inventory?

Jim, we typically do not provide guidance on cash flow from operations or cash balances. However, if we are able to reduce our inventory, that should positively influence the company's cash performance in the upcoming quarters. While I can't give specific guidance, you're on the right track. Generally, we expect inventory reductions to contribute positively to cash instead of putting pressure on it.

Okay. And then is there any update on the joint venture with Micro-X and the expansion into Southeast Asia and India?

Yes. So Jim, on the Micro-X question, we have the Micro-X announcements that we had done. We have five milestones for through R&D to pay them for the technology transfer. It is a way than acquisition financed through the P&L. In a way, you could look at it that way. One milestone was completed, and we are expecting two more milestones to be completed in Q2. That is why our operating expense guidance in Q2 is a bit higher. After that, two more milestones would be left; I do not have a specific view at this time on when the remaining two milestones would be completed. So that's that on that collaboration. And then your second question about Southeast Asia, I believe you're referring to our initiatives in India. Is that right?

Right.

Yes. So in India, we're making progress. We've made incremental progress at this time; we've made certain payments to the government for acquiring the land. We are just in the final phases of completing that purchase. Hopefully, we have made the payments, and now we are trying to work towards getting the position and those types of agreements done. Progress is full speed on that initiative. I look forward to having good things come out of that initiative in 12 to 18 months, more like 18 months, I would say.

Okay. And then the last one for me, can you just repeat comments you made regarding interest expense and share count for the second quarter?

Yes. In terms of share count, given our EPS guidance range used for due to ASU 2026, our share count for EPS calculation purposes, toggles between 41 million shares or 49 million shares. For the Q2 guidance range for EPS, we are using 41 million shares. The second question, Jim?

The interest expense.

Interest expense, I would just model, I did not provide any guidance on interest expense, but there should be at least at this point. No change from Q1 really, whatever debt we are carrying, $200 million on convertible that is at 4% and about $243 million on high-yield note that's about 7.875 interest rate. That should continue. I just want to remind you, maybe you heard our comments. I just want to remind you that coupon on both the debts is payable in the same quarter. So we pay coupon interest payments in Q1 and Q3. We're not expecting a cash coupon payment in Q2, but of course, we would recognize the expense over Q2 for that.

Got it. All right. Thank you.

Thank you. Our next question is from Michael with Mizuho Securities. Please go ahead with your question.

Hey, everyone. How are you doing? I've noticed that you've been holding a considerable amount of cash. I also came across some comments from the recent equity conference you attended. How are you assessing your capital structure? I know you've redeemed bonds a few times, and it seems you have one call available left. Are you planning to accumulate cash until you approach that convertible maturity? Or what are your thoughts on the capital structure and cash utilization in relation to that?

Yes. Thanks Mike. So what we have said is that we want to keep $100 million of cash as operating cash and we reported about $108 million of total cash at the end of the December quarter. We do not have that much more cash that we are carrying at this time compared to the cash levels that I would like to carry for general operations. I want to remind you that our cash is distributed across various geographies. We are a multinational company, and movement of cash sometimes may have bad tax consequences, so as a result, cash is not in one place. That said, your comment in terms of one tranche that is possible for us to pay that is true. Every calendar year, we can pay down 10% of our high-yield notes. That gives us an opportunity to pay down about $24 million in debt as when we have sufficient cash to pay that down and provided our Board of Directors approves that. We have highlighted that retiring that is a high priority for us. As we look towards our business, typically we generate cash, so as our cash from operations improves, our cash balance. We would like to bring down the overall debt levels. Right now, the debt levels are about $450 million on the company. We would like to bring it down by about $100 million. When is the right time for that? Depends on various factors, but that’s something we would like to get to.

Okay, great. And then you did mention that your coupons are both coincidentally in the same quarters Q1 and Q3. So Q2 and Q4 should be sort of a cash influx, right, relative to sort of what we saw this quarter? So your high watermarks on cash generally going to be Q2 and Q4, does that sound right?

In general, from a modeling perspective, that is right. But from tactical, prospective AR, AP, and then etc. And it pertains to that. In general, your thinking is right. But we would like to make sure we have sufficient room over that in terms of tactical movements. But in general, your thought is on the right direction, Mike.

Okay, great. Well, thank you very much for taking my question.

Thank you, Mike. Take care.

Thank you. There are no further questions at this time. I'd like to turn the floor back over to Christopher Belfiore for any closing comments.

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

Yes, thank you, Chris. In closing, the quarter met our expectations despite facing gross margin pressure from the revenue mix. Economic uncertainty is fostering caution in various industries. However, we view the healthcare sector as a long-term stable growth area. I am very proud of the efforts our employees are making globally in this uncertain environment. I appreciate you taking the time to join us today and for your continued interest in Varex. Thank you.

Thanks, 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 this quarterly conference will be available through February 14 and can be accessed at our website vareximaging.com/investors or by calling 877-660-6853 from anywhere in the U.S. or 201-612-7415 from non-U.S. locations. The replay conference call access code is 13735486. Thank you and goodbye.

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