Varex Imaging Corp Q4 FY2024 Earnings Call

Greetings, and welcome to the Varex Fourth Quarter Fiscal Year 2024 Earnings Call. At this time, all participants are in a listen-only mode. A 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. You may begin.

Good afternoon, and welcome to Varex Imaging's earnings conference call for the fourth quarter of fiscal year 2024. 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 2024. In addition, unless otherwise stated, quarterly comparisons are made year-over-year from the fourth quarter of fiscal year 2024 to the fourth quarter of fiscal year 2023. 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.

Thank you, Chris. Good afternoon, everyone, and thank you for joining us for our fourth quarter earnings call. Fourth quarter revenues were at the high end of our guidance range, driven mainly by continued strength in our Industrial segment. During the quarter, we experienced the continued effect of destocking actions by our customers in the medical segment outside of China. However, we believe customer inventory adjustment actions are beginning to stabilize and expect the effect of destocking to subside in the second quarter of fiscal 2025. Gross margin in the fourth quarter was at the low end of our guidance range as unfavorable sales mix in our Industrial segment due to a high proportion of equipment sales continued in the quarter. We expect the strong growth of equipment sales to drive higher margin services in the future. Revenue in our China business remained stable for the quarter, although that business overall is running at lower levels than in fiscal 2023. We are optimistic that medical imaging demand will improve in China and Varex is well-positioned to benefit when growth resumes. While we have not yet seen a measurable uptick in our incoming order rate, we are encouraged by the potential of stimulus funds making their way into the healthcare system. Turning to fourth quarter results. Revenue in the quarter decreased 10% year-over-year. Revenue in the Medical segment decreased 12% year-over-year, while Industrial segment revenue decreased 4% year-over-year. Non-GAAP gross margin in the fourth quarter was 33%, adjusted EBITDA in the fourth quarter was $23 million and non-GAAP EPS was $0.19. We ended the fourth quarter and fiscal year with $213 million of cash, cash equivalents, and marketable securities on the balance sheet, up $18 million compared to prior fiscal year end. Let me give you some insights into sales detailed by modality in the quarter compared to a five-quarter average, which we refer to as sales trends. Sales in our Medical segment were down in the quarter, primarily due to continued inventory management by our customers. Global sales in CT and oncology modalities in the quarter were flat compared to trend, while sales in radiographic modality continued to be above trend. Sales in fluoroscopy, dental, and mammography modalities in the quarter were all below their respective sales trends. In our Industrial segment, our customers continue to benefit from strong demand in security screening, driving sales of our cargo inspection products in the quarter. Other industrial end markets, primarily semiconductor, electronics, and battery inspection continued to remain soft in the quarter. Switching gears to fiscal 2025, we're excited about several initiatives that will drive growth in future years. A significant portion of our business each year comes from repeat product purchases from existing customers. This is what we refer to as our core business. To grow the core, we need to continue to innovate and refresh our current product portfolio to get designed into subsequent system models that our customers plan to release. To accomplish this, we work closely with our customers as they develop or update their imaging systems, primarily in areas of CT, dynamic detector applications and in industrial imaging applications. In our existing CT tube business, we're investing in the premium tier to include capabilities to support high-resolution, higher speed, and cardiovascular applications. We believe the premium tier is growing at a higher rate with higher margins compared to the rest of the CT market. Since CT tubes are the largest revenue contributing modality within our medical segment and require replacement at a higher frequency, staying in step with our customers' R&D plans is important for our profitable growth. We are very happy with the performance of our IGZO-based Azure detector platform, which we launched last year with great success. This platform enables high-quality imaging at a lower cost compared to CMOS-based detectors. In fiscal 2025, we are going to continue to expand our portfolio of Azure dynamic detectors to include additional products for premium applications such as surgery, oncology, and cardiology. We are continuing to migrate customers from legacy amorphous silicon products to the Azure platform and pursuing design wins in premium applications. In our Industrial segment, radiographic inspection applications for castings, pipelines, and additive manufacturing continue to evolve from using film to digital detectors. These applications demand versatile detectors with high resolution that are bendable to address complex use cases. We believe we are well-positioned to address both these needs along with differentiated software and image processing to accelerate analog to digital conversion in the growing non-destructive inspection space. In addition, we're investing in digital detectors for automotive and aerospace verticals, where we see a growing need for large area imaging with high-energy x-ray sources. Investment in platforms like CT, Azure, and bendable industrial detectors in growing application areas enables us to expand our leadership position with margin-accretive revenue contribution. We expect fiscal 2025 to be a year where we take meaningful steps with a number of novel technologies. We have been laser-focused on developing our photon counting technologies, which we believe can be a key enabler for fast, high-resolution and low radiation dose spectral imaging. We expect adoption of photon counting technology, especially in next-generation CTs to be a new and significant revenue growth driver for Varex. Varex is a leading merchant manufacturer and supplier of photon counting technologies. We are actively engaged with large imaging OEMs to integrate our photon counting detector technology in their next-generation CT system designs. We are excited about the prospects of working with these OEMs as well as other medical imaging OEMs to drive further adoption of photon counting technologies. In our Industrial segment, where we currently generate the majority of photon counting revenues, we are expanding applications and our customer base. Specifically, we're seeing continued interest and adoption by new OEMs in both food and recycling inspection applications. We're excited about these verticals as well as growing opportunities in battery, oil and gas, security, and aerospace inspection. We believe that the industry is at an inflection point in both our medical and industrial segments with photon counting and we expect to see increased adoption in fiscal 2025. Given the potential size of the photon counting market and our position as a leading merchant supplier, we anticipate an increase in revenue contribution from products using this technology in the near future. As we highlighted earlier this year, we target Photon Counting Technologies to contribute approximately $150 million in annual revenue by fiscal 2029. In our Industrial segment, we are excited to bring a portfolio of cargo inspection systems that include a portal, a gantry, a mobile scanner, and a car scanner to the security inspection market. In fiscal 2025, we plan to launch these solutions, utilizing our years of experience integrating our high-energy linear accelerators into third-party scanning systems. We know these applications very well as we have provided the core imaging components such as linear accelerators, detectors, software, and services for these types of systems for many years, and we believe we can provide differentiated value directly to end customers. I'm happy to say that we have successfully completed a few cargo inspection systems installations and have additional installations underway. We are working actively to establish distribution channels and participate in tenders worldwide. This end-market is tender-driven and can be very lumpy, but we see a long-term potential for revenue and margin contribution from equipment and services with these solutions. Our India expansion plans continue to make progress and we remain on track to begin production of components in India during the third quarter of fiscal 2025. Our initial objective for India is to establish low-cost manufacturing for our radiographic components in a very competitive market. We have outstanding product knowledge and, with an improved cost structure, we're confident that we can grow our sales of radiographic components. In the past, we have talked about our investments in Nanotube or cold cathode technology. We recently completed a full technology transfer with Micro-X. We're pleased to announce that we will begin shipping evaluation kits consisting of nanotube-based x-ray tubes and tube control electronics to several customers. In addition, our R&D teams are engaged with OEM customers who are in early stages of commercializing this novel technology, and we look forward to working with them to bring innovative systems to market. As we look forward to fiscal 2025, we believe we are taking the necessary steps to expand our leadership and drive future growth. As noted earlier, in terms of market dynamics, we expect the impact of destocking by medical OEMs to subside in the second quarter of fiscal 2025. In China, while we have not seen a measurable uptick in our incoming order rate, we are encouraged by the potential of stimulus funds making their way into the healthcare system. Before handing the call to Sam, I'd like to briefly touch on the effect of potential changes to tariffs on our business. The effect is currently unknown, but we will continue to monitor developments in this area and adjust our operations where possible. Meanwhile, we continue to advance our local-for-local manufacturing as well as supplier diversification strategies. Our initiative to manufacture in India for global consumption may also help mitigate some of the impact of potential changes in tariff policies.

Thank you, Sunny, and hello, everyone. In the fourth quarter, we reported revenues of $206 million, which is at the high end of our guidance range. Our non-GAAP gross margin was 33%, at the low end of the projected range, while our non-GAAP EPS reached $0.19, surpassing the upper limit of our guidance. Compared to the same quarter in fiscal 2023, revenues declined by 10%, mainly due to a 12% drop in our Medical segment because of ongoing inventory adjustments by our customers. Despite a solid performance, our Industrial segment saw a 4% decrease year-over-year, primarily as it was compared against last year’s record revenues in Q4. Medical revenues were $144 million, constituting 70% of our total, while Industrial revenues accounted for 30%. For fiscal 2024, the proportions were 72% for Medical and 28% for Industrial. Analyzing by region, the Americas experienced an 11% decline compared to the fourth quarter of fiscal 2023, with EMEA revenues down by 8% and APAC revenues falling by 9%. Our sales to China for fiscal 2024 reached $118 million, a 20% decline from the previous year, making up 15% of Varex's sales. We are cautiously optimistic about a sequential increase in sales to China as we see early signs of the anti-corruption campaign easing and stimulus funds beginning to circulate, although major capital equipment investments are still pending. Now, let’s discuss our results on a GAAP basis. The gross margin for the fourth quarter stood at 33%, which is a decrease of 170 basis points year-over-year. Operating expenses increased to $56 million, reflecting a $2 million uptick from the fourth quarter of fiscal 2023. Operating income fell to $11 million, dropping $13 million from Q4 of the previous year, resulting in a net loss of $50 million, mainly due to a non-cash tax charge of $52 million. Our GAAP EPS was a loss of $1.22 based on fully diluted shares of 41 million. The non-GAAP gross margin for the quarter was also 33%, down 270 basis points year-over-year, mainly due to lower volume and an unfavorable sales mix in our Industrial segment. The mix was adversely impacted by higher equipment sales and lower service sales. For the full fiscal 2024, gross margin was 32%, a decline of 110 basis points compared to fiscal 2023, attributable to the same issues of lower volume and an unfavorable industrial sales mix. R&D spending in Q4 was $22 million, consistent with the fourth quarter of fiscal 2023, making up 11% of revenues. SG&A expenses rose to $31 million, up about $2 million from the previous year, representing 15% of revenues. This resulted in total operating expenses of $53 million, an increase of $2 million year-over-year and accounting for 26% of revenues. For fiscal 2024, operating expenses were $210 million, marking a 5% increase from fiscal 2023 and representing 26% of revenues. Operating income was $14 million, down $15 million from the previous year, and the operating margin was 7%, decreasing from 13% in Q4 of fiscal 2023. For the full year, operating income totaled $52 million with an operating margin of 6%. The tax expense in the fourth quarter amounted to a benefit of $2 million, or negative 30% of pre-tax income, compared to $1 million or 6% in the same quarter of fiscal 2023, primarily due to favorable adjustments in the U.S. and Germany on full-year tax returns. Because of this, the tax expense for fiscal 2024 was unusually low at $1 million or 3% of pre-tax income. Net earnings for the quarter were $8 million, or $0.19 per diluted share, down from $0.45 in the same quarter last year. Average diluted shares on a non-GAAP basis were 41 million. For fiscal 2024, net earnings were $22 million or $0.55 per share based on average diluted shares of 41 million. Now moving to the balance sheet. Accounts receivable rose by $6 million, and days sales outstanding increased by four days to 70 days during the quarter. Inventory decreased by $17 million in Q4, and days of inventory improved by six days to 174 days. We are pleased with our inventory reduction efforts in fiscal 2024, and while some of this was due to lower sales, we remain focused on maintaining efficient inventory levels going forward. Accounts payable decreased by $11 million, and days payable dropped by six days to 39 days. Turning to debt and cash flow, net cash flow from operations was strong, at $26 million for the quarter, mainly due to the $17 million decrease in inventory. We concluded the quarter with cash, cash equivalents, and marketable securities totaling $213 million, an increase of $21 million from Q3 2024 and $18 million from fiscal year-end 2023. This amount includes $169 million of cash and cash equivalents on the balance sheet, $41 million in marketable securities, and $3 million in certificates of deposit recorded as prepaid expense and other current assets. Gross debt outstanding at the end of the quarter was $447 million, and after considering $213 million of cash and securities, net debt stood at $234 million. Adjusted EBITDA for the quarter was $23 million, with an adjusted EBITDA margin of 11% of sales. Our adjusted EBITDA for fiscal 2024 was $89 million, also representing 11% of sales. Our net debt leverage ratio was 2.6 times adjusted EBITDA on a trailing 12-month basis. Now looking ahead to the first quarter of fiscal 2025, we expect sales to China to stabilize at current levels. We are encouraged by the possibility of stimulus funds in China being distributed to the provinces, though we have not yet seen a corresponding impact on our incoming orders. We anticipate a decrease in destocking by our medical customers in the second quarter of fiscal 2025. Before I provide the guidance details, please note that Q1 of 2025 will include 14 weeks of operating results, which is important for evaluating seasonal trends for the following quarter. The additional week is projected to contribute about $15 million in revenue in Q1. Revenues for the first quarter are forecasted to be between $195 million and $215 million, while non-GAAP EPS is expected to range between a loss of $0.05 and a profit of $0.10 per share. Our expectations are built on a non-GAAP gross margin of approximately 31%, non-GAAP operating expenses of around $53 million, which includes $1 million for the final Micro-X-related milestone payment, and the impact of the extra operating weeks. Interest and other expenses are anticipated to be between $7 million and $8 million, with a tax rate of about 22% for the quarter, and a non-GAAP diluted share count of approximately 41 million shares. With that, we will now open the call for your questions.

Thank you. We will now begin the question-and-answer session. Our first question comes from Suraj Kalia with Oppenheimer and Company. Please go ahead with your question.

Sunny, Sam, hope you're well. Congrats on a nice quarter.

Thank you.

Thank you.

So Sunny, couple of questions for you and one for Sam. Sunny, obviously, China stimulus, right, it has been part of your prepared remarks. How are you all thinking about the level of China stimulus? And part of the reason I ask is, our field checks are suggesting that the level of China stimulus may not necessarily align with original expectations. I'd love to get your color on that. And how you all are adapting to the level of the stimulus?

So, Suraj, we have noted an increase in our orders in China, but we cannot yet link that to the stimulus. The increase hasn't been significant enough for us to conclude that the stimulus program has impacted the entire system, including the provinces, healthcare systems, and ultimately the OEMs and us. We have not yet felt the effects, which is why things are subdued for us at the moment, and we're monitoring the situation. While any stimulus is beneficial and we appreciate it, we still have not noticed its impact. This is the reason we're cautious with our growth projections for China.

So FY 2025 is not necessarily predicated on a certain level of stimulus flowing through. Is that the right way to think about it?

That is correct. And the way we're seeing it at this time, we have not made any significant assumptions based on any stimulus.

And Suraj, just one other element I wanted to add is that I think we would agree with you that only a portion of the overall package is going towards healthcare and perhaps we would have been more pleased if that quantum for healthcare was a little bit more.

Fair enough. Sunny, photon counting, right, I think the benefits of photon counting are pretty obvious. At least theoretically, they are pretty obvious, right? But Sunny, as you all rollout, and this is on an apples-to-apples basis, it is a smaller market currently, how do you think about differential market share gains as the velocity of photon counting picks up, and adoption picks up? GE has their own photon counting, Phillips has their own, you guys providing to OEMs of their own. So what differentiates necessarily one from the other to cause market share gains for you all?

Yes, that's a great question, Suraj. First, it's clear that the advantages of photon counting technology are now recognized, which gives us confidence that we are at a point where adoption will begin to rise as many original equipment manufacturers start exploring various applications. We categorize photon counting into several areas where we believe we can stand out. It involves both hardware and software components. On the hardware front, the speed of the detector and its capacity to handle a significant number of photon counts per millimeter square per second are crucial for two reasons. Firstly, it determines the types of applications it can support. Secondly, it allows for the creation of multiple energy bins. This capability for substantial energy separation is appealing because it enables more precise material discrimination, potentially enhancing clinical outcomes by decreasing reliance on contrast media. When an application benefits in this way, we begin to see a distinction among different technologies. Our focus includes factors such as resolution, speed, sensitivity of the detector, and the ability to process multiple energy bins, primarily on the hardware side. On the software side, our extensive experience with digital detectors allows us to optimize image processing to further amplify the output from these detectors. In summary, that's how we aim to position ourselves as leaders in this space.

And what is the price elasticity of demand in photon counting?

At this time, most applications are concentrated on the premium tiers of the CT systems. We have customers collaborating with us who are exploring both the high tiers and the goal of making the technology more accessible in the mid to upper tiers. Additionally, we have customers interested in various applications, including different forms of tomography and tomosynthesis. It's still early in the development of the technology, which means costs are higher. As we begin to scale, we anticipate that the industry will shift towards better pricing and cost structures that will facilitate broader technology adoption. We experienced a similar cycle with digital detectors, so I'm uncertain about your reference to price elasticity. Currently, our OEMs are primarily focused on developing the right applications, aware that the technologies are still in early stages and costly. However, one of our advantages is that we serve both the medical and industrial sectors, allowing us to leverage scale across OEMs and different market areas. This capability helps us benefit from economies of scale. The highest cost associated with this technology is the material itself, cadmium telluride.

Yes, I understand. Sam, I promised this would be my last question and then I’ll return to the queue. Regarding gross margins, you have a roadmap for expanding them. At this point, how much do you think the incremental gross margins are driven by macro events compared to company-specific synergies that can be implemented to improve marginal gross margins from this point forward? Congratulations again, and thank you for addressing my questions.

Yes. So thanks, Suraj. There are company-level energies and efforts and initiatives that we've been taking to improve our gross margin. If you look at our medical segment, and as you know, we disclose gross margins by medical and industrial segments. On the Medical segment, gross margins have improved steadily over the last few quarters. And there we are benefiting from freight cost reduction, supplier diversification efforts, vertical integration, also currently in medical gross margin benefits because the mix is a little bit less from China. And then also at this time, we are benefiting from the pricing-related efforts that we executed on previously. So on the Medical segment, we have improved the gross margin. But when it comes to the Industrial segment and our Industrial segment has been growing faster than our Medical segment and that is also a segment where generally we have higher gross margins. So what is happening with the Industrial segment, even though sales are increasing, our gross margins have steadily come down. So generally, if the industrial proportion of sales is increasing, we would have seen our gross margins pick up, but that has not been the case. And that is because we are shipping unusually high volume of linear accelerators into the cargo inspection market. And these products are at low margins, much lower than corporate gross margin. And as their volume has picked up, that has brought the overall gross margin for the industrial segment down. So overall, corporate gross margins have been weighed down by the industrial segment's gross margin. We hope and some of this is our energies, but then at the same time, some of this is also market-driven. We hope to swap this volume with higher-margin industrial tubes, industrial detectors or cargo systems. So as the industrial segment picks up, along with the medical segment gross margin improvements that we have made, I think we remain on point to continue to work towards mid-30s type of gross margin. But those are the things. I would also say that the overall volume needs to pick up, particularly destocking needs to subside. We are seeing tailwinds of that, so that should be helpful. Also when China comes back, although from a mix perspective, it would be margin-dilutive, but from an overall volume perspective, it might help us. So those are some of the market-driven dynamics and I also talked about some of the energies that we've been working on in this area.

Thank you.

Thank you. Our next question comes from the line of Kyle Bauser with B. Riley Securities. Please proceed with your question.

Hi, everyone. Great quarter and thanks for taking my questions. Maybe I'll start in the oncology segment. It looks like it stabilized compared to last quarter and the five-quarter average. Can you talk about any dynamics that cause this or is there anything to call out here?

Hi, Kyle, this is Sunny. No particular dynamic that I can pinpoint to other than perhaps the destocking phenomenon, you know, was starting to subside there as well. It's been more or less the same type of same products, nothing unusual.

Got it. And maybe we'll stick on the destocking situation. So glad to hear you expect it to kind of stabilize by the second fiscal quarter, and you talked about it kind of already seeing that pattern in the oncology segment. Can you talk a bit more about what you're seeing here to give you confidence? Is it the ordering patterns or discussions with clients that give you confidence here? Any color would be great.

Yes, I'll begin and perhaps Sam can add his insights. A few quarters ago, we noted that our primary indicator is the rate of inbound order intake. We have a quick order to shipment process, so fluctuations in the order intake rate provide early signals regarding market conditions, typically looking about 90 days ahead. We observed a decline in this rate and engaged with our customers, which led to stabilization and early signs of increases, especially in China. This insight, coupled with our discussions with customers, suggests they are nearing the end of their cleanup phases. Additionally, December marks the year-end for many of our customers, so we see the usual year-end adjustments. Collectively, these factors indicate that we may be moving past this situation, and we anticipate that by the first quarter of the calendar year, it will be behind us.

Great. I appreciate that color. And then lastly, if I may, maybe regarding capital expenditures, how should we think about this line-item to trend given the company's current initiatives and growth strategy? Should we anticipate a similar kind of quarterly cadence of $5 million to $6 million?

Yes, Kyle, this is Sam. Let me take that question. So in terms of our capital expenditure plan of a majority of our investment in fiscal 2024, we just completed and also into this coming year is targeted towards building up the infrastructure and the manufacturing capability out of India. So 2024 was a little bit higher than our five-year average on capital expenditure. And 2025 would also stay somewhat elevated. I would expect it to be in the $25 million to $30 million range. Call it flat to FY 2024 or somewhere around that. And beyond that, it should come down, but that's what we are expecting as of now for the capital expenditure for this coming fiscal year.

Okay. Excellent. Well, thanks for taking my questions.

Thank you, Kyle.

Thank you. Our next question comes from the line of Jim Sidoti with Sidoti & Company. Please proceed with your question.

Hi, good afternoon. Thanks for taking the questions. Can you get a little more specific with China? You said it's stable there. I know you did about $29 million of revenue in the third quarter. Can you break out exactly what the revenue was in the fourth-quarter and what it was a year ago?

Yes, sure. So China in the quarter just completed, Jim, was $31 million and it was $31 million in the year-ago quarter. So it is stable, although it is stable at lower levels. So the way I would characterize China is that it has stabilized at lower levels. We are not seeing any worsening. And this last quarter was $31 million, but in Q3, it was $29 million. So one might think that it has picked up. But I would say that is just quarter-to-quarter variation. We need to see a little bit more in terms of orders from China before we begin to say that it is going to pick up. The timing of that pickup is still uncertain in our mind, but it is definitely not worsening. And that's what we mean by saying that China has stabilized.

Okay. And regarding inventory management, you mentioned that you expect the destocking to ease by the second quarter. Are you noticing that customer demand continues to grow? Is that what gives you the confidence to make that statement?

I would say that on that aspect, it is mostly qualitative and it is mostly based upon our conversations with our customers, although we would get a little bit more rich conversation, so to say, although we have active dialogues with customers all the time. But once they complete their fiscal year in December and when it comes to January, February timeframe, they begin to get much more concrete with us in terms of what their expectations for the coming year are with us. So the conversations have been happening and based on I would say order rate as well as these qualitative discussions, it leads us to believe that destocking has begun to taper down. Although it will take all the way until January or something like that to fully be done, January, February, when we are currently expecting that we would be able to say that destocking is behind us.

Okay. And then last one for me is a balance sheet question. Your plant property equipment, it's up to about $5 million from the June quarter; it's up about $10 million from a year ago. Is that India or what else is contributing to that?

Yes. The PP&E is really a proxy for capital expenditure and you are right, it is mostly India. And if you look at full-year, that PP&E should be around for the fiscal just ended should be $26 million, $27 million or in that neighborhood. And coming year, we expect it to kind of remain at those levels, somewhere between $25 million and $30 million, yes.

So should we assume from that the PP&E plant is nearly complete and that should start contributing?

Yes. We are working on two factories in India, Jim. One factory, we are expecting to begin to produce products in the second half of fiscal 2025. So we have made pretty good progress there. And then the second factory is a little bit behind the first one and that would be probably nine months behind the first one. So the second one, we expect it to go into production in first part of FY 2026. But a big quantum of capital expenditure or PP&E would be behind us by the time fiscal 2025 ends, but there will still be some equipment-related spending, say, in the first half of FY 2026, but the rate of PP&E or investment would come down as we end FY 2025.

And should we assume the products made at those plants that will stay primarily in India and other parts of Asia?

No, not necessarily. Our strategy in India is focused around production in India for global consumption. Our initial strategy is to produce somewhat more competitive products in India, so that we have somewhat of a cost advantage out of production from India. So, essentially, it is a global consumption on the competitive products out of India. And that is the strategy.

Okay. Thank you.

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

Thanks, and good late afternoon to everyone. My first question is, although you typically don’t provide annual guidance, in the past you’ve shared some high-level revenue trends. For Q1, excluding the extra week, it seems you're about flat compared to last year. The midpoint is 190, which matches last year's figure, correct? Can you confirm if that's what you expect for the entire year? You've mentioned a reduction in inventory destocking, so could you share some high-level insights on your outlook beyond the typically slower Q1?

Yes. So I think, Larry, China is running at low levels, but it has stabilized. However, the timing for the growth of China is unknown at this time. And also on the destocking side, you know, we are getting more constructive or feeling better about destocking trends to kind of get completed by January, February timeframe as we said previously. So all of that is good. Those two tailwinds might be coming up our way as we get into Q2 and beyond. However, we need to be cautious at this time due to the incoming administration and potential changes to the tariff regime. So we feel like that we are not in a position to guide full-year at this time. In any ways, we generally do not guide full-year. We go quarter-by-quarter. And so when you take all of these perspectives in mind, we are just providing one quarter at a time.

Okay. And the tariffs specifically, I thought you guys have reduced most of your exposure to that already. So how would the tariffs actually higher tariffs impact you specifically or if you can just not quantify it, but just qualitatively?

Tariffs affect us in two main ways. First, with input costs for items imported into the US. For those coming from China, the rates will be higher, while those from other countries will face a 20% rate. This impacts our input costs. In the past, we’ve managed to obtain exemptions and duty drawbacks for our exports, which helps mitigate some of the effects. The more challenging aspect is dealing with tariffs on completed products shipped out of the US, especially as retaliatory tariffs can influence sales and affect gross margins unpredictably. We cannot precisely foresee these retaliatory actions at this time. In 2018, we were in a different position regarding tariffs. Since then, we have developed a stronger local-for-local presence, enabling us to manufacture certain products in China for the Chinese market. Additionally, we now have detector manufacturing capabilities in China, allowing us to retain that business, which wasn't the case during the previous tariff situation. Our resilience has improved considerably, which should benefit us in the current scenario. Moreover, our investments in India are aimed at establishing redundancy in our global supply chain, providing us with an advantage in the long term.

Got you. And the gross margin outlook for 31%, again, I know you don't want to guide to future quarters, but I assume that margin is also artificially depressed because of seasonality, right? Your slower volumes is an extra week, but you also have an extra week of cost, right? So I feel like, again, you don't know what's going to happen with tariffs or I feel like it doesn't impact you that fast anyhow, I would say. But as we look out over the next couple of quarters, I would feel like gross margin probably should come up a little bit, right? I mean that the quarter-over-quarter drop is that based on lower sales over the next extra one-week or what's that drop, I guess, the starters? Is it industrial?

Yes. So Larry, there are a couple of themes to consider. When we look at the Q1 guidance for gross margin, excluding the additional week, we're at $190 million. Last year in the same quarter, we were also at $190 million, and the gross margin then was 31%. So that provides a year-over-year comparison for you; we are maintaining that level. However, $190 million in business is certainly below what we consider optimal, indicating that there is an impact on gross margin from scale or volume if we consider Q1 as a standard 13-week quarter. We clearly have that scale effect in play. We anticipate that, on a 13-week-to-13-week basis, we will increase volume throughout the year, which should positively influence gross margin. Therefore, we expect to see growth in gross margin as we move past Q1, similar to our performance in FY 2023.

Got you. Okay. If I could just ask one last question about the increased security solutions. First, I know there are a couple of larger companies out there that you would be competing against. These companies are your customers since you sell linear accelerators to them, right? Is it a challenge to compete with your customers? That's my first question. For the second part, are you targeting the same customers? Most of your sales that I am aware of have been made to government bodies in the US, Mexico, and other international locations. Are you targeting the same customers, or is your equipment aimed at smaller or more private customers? I noticed some of the product images on your website, including some drive-through solutions and offerings for cargo and passenger vehicles. Any insights on this would be appreciated. Thanks.

Yes. Larry, we believe we can play in this space both as a supplier of components to the other players in this space and also with full systems. Now even historically, we have sold subsystems, which consists of our linear accelerator detectors, our software packages, a variety of things that then someone else, a systems integrator would take and go to market. And so we believe we can do a good job of doing both. And we've spoken with our customers about this. They know what we're doing, they understand it, and we have differentiated products that make it worth their while to buy those from us. The space is big. It's large, it is growing and we believe that the types of applications are continuing to grow as well. It used to be only ports and borders now with smaller footprint and mobile applications, it's expanding to other sites. You're seeing them at venues, you're in future, you're going to see them in garages and other places. So we think there's plenty of opportunity in this market for differentiated applications.

Got you. So you will be targeting more some smaller one-off type places or maybe not one-offs, but maybe garages, maybe you get a string of 10 garages that is owned by an operator, but it feels like you're also going to be targeting some more smaller locations than at least the bigger guys have been speaking to. Is that fair to say?

We will participate based on our products and capabilities. I believe you are talking about car scanners, which is one of our products where we can excel in a specific market. Other established players have the scale, potential, and presence that we are just beginning to develop. We are starting from a small base. Many people may not know that we have several systems currently operational at the US-Mexico border through Customs and Border Patrol, with around 20 already installed. We have experience in this area, but initially, we will focus on opportunities where we feel we can stand out.

I appreciate that. I appreciate the color. Thanks. Bye.

Thank you, Larry. Thank you.

Thank you. We have reached the end of the question-and-answer session. I'll now turn the call back over to Christopher Belfiore for closing remarks.

Thank you. Thank you all for participating in our earnings conference call for the fourth quarter of fiscal year 2024. The webcast and supplemental slide presentation will be archived on our website. A replay of the quarterly conference call will be available through December 3rd and can be accessed at vareximaging.com/investor-relations. Thank you, and have a great evening.

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