Earnings Call Transcript - VREX Q3 2025

Operator, Operator

Greetings, and welcome to the Varex Third Quarter Fiscal Year 2025 Earnings Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Chris Belfiore.

Christopher John Belfiore, Host

Good afternoon, and welcome to Varex Imaging Corporation's earnings conference call for the third quarter of fiscal year 2025. 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. 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 third quarter of fiscal year 2025. In addition, unless otherwise stated, quarterly comparisons are made year-over-year from the third quarter of fiscal year 2025 to the third quarter of fiscal year 2024. 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 information, 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 S. Sanyal, CEO

Thank you, Chris. Good afternoon, everyone, and thank you for joining us for our third quarter earnings call. We are pleased to report that third quarter revenue of $203 million was above the high end of our guidance. During this quarter, we saw continued strength in our Industrial segment and our revenue in China was better than forecasted and in line with the recent quarters. You may recall that our Chinese customers had asked us to hold shipments earlier in the quarter when tariffs were around 145% levels. As expected, once the tariffs dropped to around 55%, customers resumed their delivery requests. I'm happy to say that we were able to accommodate their shipment needs. On a related note, concurrent with the reduction in tariffs, the Ministry of Commerce in China paused both investigations that it had launched in early April. Non-GAAP gross margin of 34% in the quarter was above the high end of our guidance. Compared to expectations, gross margin benefited from higher volume and favorable product sales mix as well as lower impact from tariff-related expenses compared to expectations. I'm also happy to say that during the quarter, we paid off our $200 million convertible notes, which reduces our overall debt burden and simplifies our capital structure. Turning to third quarter results. Total revenue was down 3% year-over-year with Medical segment down 4% and Industrial segment up 1%. Non-GAAP gross margin of 34% was 100 basis points higher than in the same quarter last year. Non-GAAP earnings per share in the third quarter was $0.18, up $0.04 compared to last year. We ended the third quarter with $153 million of cash, cash equivalents and marketable securities on the balance sheet, down $73 million from the prior quarter. This decline was primarily due to the use of cash to repay our $200 million convertible note. Let me give you some insights into sales detail by modality in the quarter compared to a 5-quarter average, which we refer to as the sales trend. Global sales of CT tubes remained strong in the quarter and were in line with the sales trend. Sales in oncology and mammography modalities were above their respective sales trends in the quarter, while sales in radiography and dental modalities were in line with their respective sales trends. Sales in our fluoroscopy modality were below its sales trend. Demand in our Industrial segment remained strong in the quarter. Need for security screening globally continued to drive sales of cargo inspection components as well as our recently launched security inspection systems. Similar to prior quarters, strong demand for check baggage inspection and cargo screening at airports as well as non-destructive inspection in other verticals drove growth in our industrial X-ray tubes product line. Moving to some product highlights. In Medical, we continue to make progress with our India expansion plans and expect to begin production of radiographic detectors around fiscal year-end. As mentioned previously, our objective for India is to establish low-cost manufacturing for value tier radiographic components where we face competition from Asia-based companies. We expect our factories in India to be a key enabler for driving growth in radiographic components in the coming years. Since our announcement at RSNA, customer interest for LUMEN HD detectors continues to grow, and we are providing customers and prospects with detectors so that they can do their integration and validation. The LUMEN HD and HD Pro digital radiography detectors are our new competitively-priced family of detectors, which offer superior image quality, high reliability, fast image acquisition with lightweight and very user-friendly design and several options for workflow improvement. As mentioned before, this product line is expected to showcase both our innovation and cost leadership and our goal is to gain share globally with these detectors. We have received all necessary regulatory licenses for the U.S. and Europe and we have begun shipping certain models from our Salt Lake City factory. We expect to begin manufacturing and shipping these products from one of our factories in India around fiscal year-end. In photon counting, we're making progress as expected with a couple of OEMs who are integrating our technology in their new systems and these projects are moving forward. Meanwhile, we're also in different stages with other prospective customers who are exploring their design options for CT and other applications. We recently released for general availability a photon counting detector called THOR for very high-speed industrial CT imaging. Potential applications for THOR include non-disruptive, non-destructive testing for EV batteries, semiconductor components, food and material sorting applications. This detector is engineered to operate in demanding industrial applications where both precision and high-speed imaging is a critical requirement. On the systems side of our business, in our Industrial segment, cargo systems continue to perform well. Varex was honored to have its VXM6 mobile X-ray inspection systems on display at the Blue Light Show in London this past quarter. This is a show highlighting key technology for emergency service teams, enabling them to keep communities safe. This is precisely what the versatility of the mobile X-ray system provides, securing various sites and allowing the emergency response teams to have the flexibility and mobility of deploying the mobile X-ray unit when and where needed. On July 14, we announced additional new orders worth $17 million for cargo inspection systems for international customers to help secure sea and land ports. These new orders bring our year-to-date bookings to over $55 million, which is a testament to our strong reputation for quality and innovation in high-energy linear accelerator-based imaging. To date, we have installed and commissioned several systems in Saudi Arabia, Turkey, Colombia and Bangladesh. Additionally, we're in various stages of implementation of portals, gantries and mobile systems in Brazil, Ukraine, Mexico and expanding to other locations in Saudi Arabia. A typical cargo inspection system consists of a linear accelerator, which is the source of high-energy X-rays, an array of detectors, software for image acquisition, image viewing and workflow and an electromechanical framework that ties it all together. We are a vertically integrated systems provider and build each of the major components ourselves. We also have legacy competency in building and deploying full systems, many of which are still in use by the U.S. Customs and Border Protection. We believe that being vertically integrated gives us a distinct advantage. By being able to bring innovation to each component, we believe that we can serve the cargo inspection industry better and more cost-effectively. These capabilities resonate with our current and prospective customers. Through our knowledge and legacy experience in cargo systems, supplemented by small asset purchase, we have been successful in developing systems integration capability out of our facility in Stoke-on-Trent in the United Kingdom. At the same time, we have been investing in our Las Vegas facility that provides components to our U.K.-based operations as well as for the broader security inspection industry customers. We are ramping up systems production at our facility in the U.K. and investing in customer demonstration capabilities in both the U.K. and in the U.S. We have a well-established services team and a part supply and logistics infrastructure with global reach through whom we are installing and servicing our customers. We are prepared to expand these capabilities as the business grows. We have been focused on developing our sales channel, which includes Varex employees, in-country agents who we have known for many years as well as several application specialists and engineers who support the sales process. We have an active pipeline of projects that we are bidding in and continue to develop our future sales funnel of prospects for new business opportunities globally. In summary, our Industrial segment continues to perform well and we are seeing positive trends across our Medical segment despite a very challenging and constantly changing global trade environment. We expect to finish out the fiscal year on a strong note. I'd like to thank all our employees globally for their hard work and commitment in helping us deliver a solid quarter. With that, let me hand over the call to our CFO, Sam Maheshwari.

Shubham Maheshwari, CFO

Thanks, Sunny, and hello, everyone. Our performance in the third quarter was better than our expectations. Revenues of $203 million were above the high end of our guidance as well as non-GAAP gross margin of 34% and non-GAAP EPS of $0.18. Comparing the third quarter to the same period in fiscal '24, revenues decreased 3%. This decrease was due to a 4% decrease in our Medical segment, partially offset by a 1% increase in our Industrial segment. Medical revenues were $142 million and Industrial revenues were $61 million. Medical revenues were 70% and Industrial revenues were 30% of our total revenues for the quarter. Analyzing revenues by region, Americas saw an increase of 1% compared to the third quarter of fiscal '24. EMEA revenues were down 2%, while APAC decreased 8% year-over-year. In the first 6 weeks of the quarter, the Chinese customers paused receiving shipments due to unusually high tariffs. However, the subsequent pause in tariffs helped them to resume receiving their deliveries during the second half of the quarter. We are pleased to meet the shipment needs of our Chinese customers. As a result, sales volume to China ended up fairly in line with the recent quarters and contributed 15% of total revenues for the company. Sales to China increased 4% for the quarter year-over-year. Let me now cover our results on a GAAP basis. Third quarter gross margin was 33%, up about 100 basis points year-over-year. Operating expenses were unusually high at $148 million, an increase of $90 million compared to the third quarter of fiscal '24. The primary driver of the increase was a non-cash goodwill impairment charge of $94 million due to a decline in the company's market cap. As a result of this non-cash charge, operating loss was reported at $81 million, net loss of $89 million and GAAP EPS loss of $2.15 per share based on a fully diluted 42 million share count. Now moving on to non-GAAP results for the quarter. Gross margin was 34%, up 100 basis points year-over-year, primarily due to a favorable product sales mix. Compared to our guidance, gross margin benefited from lower than previously anticipated impact from tariff-related expenses. R&D spending in the third quarter was $21 million, a decrease of approximately $1 million compared to the third quarter of fiscal '24 and representing 11% of revenue. SG&A expense was $30 million, a decrease of $1 million compared to the third quarter of fiscal '24 and representing 15% of revenues. Operating expenses totaled $51 million, a decrease of $2 million compared to Q3 of fiscal '24 and represented 25% of revenue. Operating income was $17 million, an increase of $2 million compared to the previous year, and operating margin was 8% of revenue, up from 7% in the third quarter of fiscal '24. Tax expense in the third quarter was $2 million or 23% of pretax income compared to $352,000 or 6% in the third quarter of fiscal '24. Net earnings were $8 million or $0.18 per diluted share, up from $0.14 in the year-ago quarter. Average diluted shares for the quarter on a non-GAAP basis were $42 million. Now turning to the balance sheet. Accounts receivable decreased by $9 million and days sales outstanding declined by 1 day to 61 days. Inventory increased by $14 million in the third quarter and days of inventory increased by 11 days to 201 days. The increase in inventory was primarily due to raw materials and work-in-process inventory related to the strength in our industrial business. Accounts payable was flat and days payable remained at 47 days. Now moving to debt and cash flow information. Net cash flow from operations was $8 million. We ended the quarter with cash, cash equivalents and marketable securities of $153 million, down $73 million compared to the second quarter of 2025. Reduction in cash and cash equivalents was due to the use of cash to pay off our convertible debt in June. Gross debt outstanding at the end of the quarter was $370 million and debt net of $153 million of cash and marketable securities was $217 million. Adjusted EBITDA for the quarter was $29 million or 14% of sales. Our trailing 12 months adjusted EBITDA was $110 million and our net debt leverage ratio was approximately 2x adjusted EBITDA on a trailing 12-month basis. Now moving on to the outlook for the fourth quarter. Guidance for the fourth quarter is as follows: revenues are expected between $210 million and $230 million, non-GAAP earnings per diluted share are expected between $0.10 and $0.30 of profit. Our expectations are based on non-GAAP gross margin of 32% to 33%, non-GAAP operating expenses of approximately $51 million, interest and other expense net in the range of $9 million to $10 million, tax rate of about 25% for the fourth quarter and non-GAAP diluted share count of about 42 million shares. With that, we'll now open the call for your questions.

Operator, Operator

Our first question comes from James Sidoti with Sidoti & Company.

James Philip Sidoti, Analyst

So it sounds like you were able to fulfill the orders to China even though you only had 6 weeks to do it in the quarter. Did that result in higher than expected expenses?

Sunny S. Sanyal, CEO

Jim, this is Sunny. No, that did not result in any particular higher than normal expenses. It was just that we have the capacity and we were glad we were able to fulfill that demand.

James Philip Sidoti, Analyst

Do you expect China sales in the fourth quarter to be on par with Q3 or possibly start to increase?

Shubham Maheshwari, CFO

So Jim, this is Sam. We do not provide guidance by region, customer, or product specifically. However, I can say that the demand in China remains stable and healthy, and it is ongoing. Unless there is an external event or unusual situation, we anticipate that it will continue at a normal level.

James Philip Sidoti, Analyst

All right. And then when you discussed the photon counting OEM, you called out one of your industrial customers. Do you have any of your medical OEMs testing the photon counting technology?

Sunny S. Sanyal, CEO

Yes. So the big CT projects are on the medical side. On the industrial side, we have ongoing activity in several different applications. But our big focus and investment in photon counting has been for medical CT.

James Philip Sidoti, Analyst

Right. And you've done a nice job paying down the debt with operating cash that you've kind of put in the bank over the past several quarters. What's the plan going forward? Do you think you'll continue to use your operating cash to pay down debt?

Shubham Maheshwari, CFO

Yes. So Jim, as you know, we have another tranche of refinancing coming, but it's about 2 years away from now. So we need to address it before next fall. So right now, we are in a very comfortable cash situation. And overall, we would like to target our debt in the $300 million to $350 million range, gross debt, I mean. So from that perspective, right now, we would like to continue to build up the cash position. So we are in a strong position when we approach refinancing in the next 12, 18 months.

James Philip Sidoti, Analyst

And the guidance you gave for $9 million to $10 million of interest expense for the fourth quarter, is that net of any interest income you get from the cash on hand?

Shubham Maheshwari, CFO

It's net, yes. Yes, it's net interest income plus the other operating and expense items. So it's those 2 items.

Sunny S. Sanyal, CEO

Yes. So it's not just pure interest expense.

Operator, Operator

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

Shaymus F. Contorno, Analyst

This is Shaymus on behalf of Suraj. Congratulations on a very strong quarter and the positive guidance for the fourth quarter. I'm trying to get a clearer picture of the overall situation. You provided an excellent outlook for the fourth quarter. Could you describe the capital spending environment and what you are observing? How sustainable is the business performance, especially on the medical side, as we head into fiscal '26? Any insights you can share would be helpful, even though I understand you might not provide specific guidance. This would aid us in starting to model our expectations.

Shubham Maheshwari, CFO

Yes, the environment appears to be healthy. The demand pattern looks good, and considering the hospital capital expenditures and overall emphasis on imaging as an investment, along with procedure volume, everything seems to be in a decent place currently. Remember, last fiscal year was relatively soft due to inventory destocking. We expect to enter fiscal '26 in a strong position regarding the macro demand environment. Is that what you were asking, Shaymus, or did I misunderstand your question?

Shaymus F. Contorno, Analyst

Yes. No, you for the most part got the gist of it. I guess kind of on a side note to that, just trying to understand, I know this is a sliding scale, so to speak, with your kind of performance in the quarter by line. I guess where are you kind of seeing strength? Because I know I think you noted like fluoroscopy is down, a lot of things have kind of been stable, so to speak. So I guess where within that Medical segment kind of are you seeing strength that's kind of leading to these kind of nicer revenue numbers?

Shubham Maheshwari, CFO

Yes. I would say from a revenue mix perspective, our Industrial business is fairly strong and CT was strong in this last quarter and that's where we are seeing. Radiographic was somewhat stable. Fluoroscopy was down. So I would say a number of modalities were stable to slightly better than stable and the strength was there in CT and Industrial.

Shaymus F. Contorno, Analyst

Okay, I appreciate that. One more question from my side. Regarding photon counting, can you provide any metrics or information on how many customers you are engaging with at various stages? Additionally, can you share rough timelines for when you anticipate around 50% of them will progress towards commercialization? I remember you mentioned a guidance number of around 27% or possibly 29% for expected sales. I'm trying to understand when we might begin to see initial orders coming in and how that will contribute to your backlog.

Sunny S. Sanyal, CEO

Let me address your question and then I'll have Sam add his insights. We have indicated that we are anticipating a $150 million contribution from photon counting, with a strong rollout on the CT side in Medical, along with about $50 million in contribution from Industrial. The Industrial sector is seeing continuous growth that is occurring now, growing incrementally. The launch of a new product like THOR, which I mentioned, will support this growth. We expect significant improvement in Industrial. Regarding Medical, we have two solid candidates and strong OEMs currently in the design implementation phase. They have moved beyond the selection process and are actively developing their systems. For the next 12 months, updates may be a bit mundane as they focus on their work. After that, we anticipate that they will begin testing and move forward in bringing systems to market. I cannot provide more specific timelines due to confidentiality with our customers, and while we are not naming names, I want to avoid any complications for them. Our previously mentioned timelines, specifically the 2029 timeframe, remain unchanged.

Shubham Maheshwari, CFO

Yes. I can also just add that we had said by 2029, we would be expecting, say, $150 million or so in photon counting revenue with, say, 2/3 of that approximately from the Medical segment and 1/3 from the Industrial segment. Now keep in mind, right now, most of the photon counting shipments are in the Industrial area. And that side of photon counting business is continuously and very nicely progressing and improving. However, on the Medical side, we expect it to be in a step basis manner. So say, about $100 million of Medical contribution for photon counting revenue would mean that we need to have 3 to 4 OEMs design our product into their systems and be rolled out. And so say, 2 quarters or so ago, we were working very strongly with 1 OEM and now we are working with 2 OEMs. And so we are pretty happy with the progress we've made and how we are moving in this direction in terms of commercializing the technology.

Sunny S. Sanyal, CEO

And as I mentioned on our call, we have others in the pipeline that are in that phase of the consultative phase where they're trying to figure out how they would integrate this into their systems. They're doing the initial physics measurements and all the things that get them ready to get their head around the next product that they're going to bring to market. So the pipeline is good and the interest remains strong. So it's on its way.

Operator, Operator

Our next question comes from the line of Young Li with Jefferies.

Xuyang Li, Analyst

I guess to start, I was curious on the China business outperformed expectations. I was wondering if you can talk a little bit about your expectations for potential outsized orders in China. Maybe some customers will take this opportunity to stock up on inventory to try to derisk future tariff updates. And also, are you seeing any impact from government stimulus in China?

Sunny S. Sanyal, CEO

Our order intake from China has been steady. In this third quarter, our sales in China were consistent with the performance over the last several quarters. Customers are not making purchases in a sporadic manner, nor have we observed them trying to predict the tariff rates, which have remained fairly stable for some time. Therefore, demand in China is steady. The only time we experienced a pause was when the tariff rate was as high as 145%, which caused everyone to hesitate, thinking that it couldn't last and would likely decrease. So, we took a short break. However, when customers resumed, they returned to their needed inventory levels. That provides the context, and I apologize for forgetting the second part of your question.

Xuyang Li, Analyst

Government stimulus impact.

Sunny S. Sanyal, CEO

Yes. As we have mentioned previously, there has been discussion around stimulus programs reaching the provinces and hospitals. However, we have not yet observed any significant signs of increased demand. It is challenging to distinguish whether changes are due to stimulus or typical market conditions. What is clear is that the Chinese government is dedicated to expanding healthcare services, and the Ministry of Health continues to advocate for the implementation of imaging technologies in rural hospitals. There are indications that they aim to have at least 164-slice CT scanners in every county hospital in China, of which there are approximately 15,000. Therefore, we anticipate that the demand for CTs will persist alongside the steady growth of healthcare services.

Xuyang Li, Analyst

I’d like to hear your thoughts on increasing system production in the U.K. and your investment in the Vegas facility regarding the industrial cargo systems business. Should we anticipate larger orders in the upcoming quarters? Could you give us some context on the order sizes? They range from $14 million to $25 million, but can we expect orders exceeding $25 million in future quarters?

Sunny S. Sanyal, CEO

The facility expansion in the U.K. is primarily to support business growth, and we have received $55 million in orders that we need to fulfill. To do this, we require additional space and personnel, which is what I was referring to. The business's health and future orders look promising, as we have a strong pipeline. Given our reputation and current presence, it seems we are involved in most of the deals available. However, there is some uncertainty about when these deals will close due to the tender-driven process. We want to ensure we don't fall behind in our delivery capabilities, so we're ramping up our operations carefully. As for the size of the deals, while I can't make specific predictions, the order sizes we've seen, around $17 million to $25 million, are typical for us.

Shubham Maheshwari, CFO

Young, I would add that in terms of our CapEx requirements, and maybe that's what you're thinking or maybe a little bit reading your mind here. From a CapEx perspective, we have guided $25 million to $30 million CapEx for the year, last year, this year as well as the coming year. That would include investments in U.K. that we plan to make to ramp up our ability to address the orders and ship the product. So that $25 million to $30 million CapEx would include this. And then I would just add that in cargo systems business, order size more than $25 million is not uncommon. So it's just our ability to compete and win. So it can happen. But at the same time, as I said, it will be great if we win those orders and then we would be able to fulfill them, but we'll be mindful about the CapEx that we need to invest in those facilities.

Operator, Operator

Our next question comes from the line of Larry Solow with CJS Securities.