Varex Imaging Corporation (NASDAQ:VREX) Q2 2023 Earnings Call Transcript May 2, 2023

Varex Imaging Corporation beats earnings expectations. Reported EPS is $0.26, expectations were $0.18.

Operator: Greetings, and welcome to the Varex Second Quarter Fiscal Year 2023 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Chris Belfiore, Director of Investor Relations. Thank you, Chris. You may begin.

Christopher Belfiore: Good afternoon and welcome to Varex Imaging Corporation’s earnings conference call for the second 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. The website 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 second quarter of fiscal year 2023. In addition, unless otherwise stated, quarterly comparisons are made sequentially from the second quarter of fiscal year 2023 to the first 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 1A, Risk Factors of our quarterly reports on Form 10-Q and our Annual Report on Form 10-K.

The information in this discussion speaks as of today’s date, and we assume no obligation to update or revise the forward-looking statements in this discussion. On today’s call, we will discuss certain non-GAAP financial measures. These non-GAAP measures are not presented in accordance with, nor are they a substitute for GAAP financial measures. We provided a reconciliation of each non-GAAP financial measure to the most directly comparable GAAP financial measure in our earnings press release, which is posted on our website. I will now turn the call over to, Sunny.

Sunny Sanyal: Thank you, Chris, and good afternoon, everyone. I’m pleased to report strong second quarter results that exceeded the high-end of our guidance. This was primarily driven by better than expected results in our Industrial segment, while the Medical segment performed in-line with our expectations. We’re encouraged by the demand levels we’re seeing and we anticipate our growth to remain solid in the second half of fiscal 2023. Revenue in the second quarter was up 11% sequentially and 6% year-over-year. Revenue in the Medical segment increased 9% sequentially and 2% year-over-year, while Industrial segment revenue increased 19% sequentially and 22% year-over-year. Non-GAAP gross margin in the second quarter was 33% which was better than our expectations primarily due to a higher proportion of industrial sales.

Adjusted EBITDA in the second quarter was $30 million and non GAAP EPS was $0.26. We ended the second quarter with $122 million of cash, cash equivalents and marketable securities on the balance sheet, up $14 million from the $108 million in the prior quarter. This was primarily due to a $9 million reduction in inventory in the quarter. Let me give you some insights into sales detail by modality in the quarter compared to a five quarter average. Medical segment revenues increased 2% year-over-year and 9% sequentially. Demand for CT tubes was solid in the quarter primarily due to the strength with our Asia-Pacific customers. Fluoroscopy and oncology were down in the quarter. Dental, which can be lumpy from quarter-to-quarter, was down in Q2 and mammography was flat in the second quarter, while radiography was up.

Revenues in our Industrial segment increased 22% year-over-year and 19% sequentially. Demand for industrial products was robust in the quarter and solidly ahead of our expectations. The strength in the quarter was primarily in our nondestructive inspection products across various end markets and service. We also continue to see improvement in security market, primarily in cargo inspection. As we highlighted last quarter, the technological capabilities of photon counting detectors continues to be a focus for many of our customers. It was a significant topic of our conversations with customers at RSNA in November as well as at the European Congress of Radiology in March. We are excited to announce that we have entered into several projects across our Medical and Industrial businesses to further demonstrate the capabilities of photon counting detectors.

In the Medical segment, we continue to make progress with our CT customers for potential integration of photon counting detectors into their systems. In order to accelerate and support these efforts, we have also entered into a publicly funded project led by Munich Institute of Biomedical Engineering, of the Technical University of Munich. The focus of the project is to develop a technology demonstrator of a photon counting CT system. This project which will utilize several Varex components in addition to photon counting detectors will allow Varex to showcase the capabilities enabled by our photon counting detector technology and CT applications, including the use of AI for enhanced imaging. We expect this project will democratize cutting edge CT technology to potentially accelerate the adoption of photon counting detectors in the next generation CT systems.

In our Industrial segment, Varex is involved in two collaborative photon counting projects named PARSEC and GRINNER. These projects are sponsored under the Horizon Europe Programme, the EU’s key funding programme for research and innovation. The first project, PARSEC, is aimed at addressing the abuse of postal and express courier services by criminals and terrorists. Varex’s role in this project is to help PARSEC enhance detection of threats and illicit goods in the postal and express courier flows and achieve higher levels of detection performance. Varex will deploy its photon counting technology to assist users in achieving these objectives. The second project, GRINNER, is aimed at addressing issues affecting battery caused fires in electrical and electronic equipment waste management chain.

These fires can cause significant damage and high costs for waste management companies. Varex’s role in this project is to help develop an AI powered battery detection system utilizing our photon counting detectors. Across all these three highly innovative projects, we are thankful for the partnerships and associated funding, which help accelerate further development and the use of our technologies in the Medical and Industrial fields. We are encouraged by the demand trends that we are seeing across both segments and expect the solid performance to continue in the second half of fiscal 2023. We believe the supply chain situation for our customers is improving and as a result, we expect revenue in fiscal 2023 to grow 3% to 5% over fiscal 2022.

With that, let me hand over the call to, Sam.

Sam Maheshwari: Thanks, Sunny, and hello everyone. As a reminder, unless otherwise indicated, I’ll provide sequential comparisons of our results for the second quarter of fiscal 2023 with those of our first quarter fiscal 2023. I’m pleased to report solid results for the second quarter compared to our guidance. We exceeded our guidance for revenue gross margin and non-GAAP EPS and generated $27 million of operating cash flow in the quarter. A primary driver of the strong performance was excellent execution in our Industrial segment, which was significantly above recent run rates. As a result, we reported sales of $228 million and non-GAAP gross margin of 33%. The higher gross margin is primarily the result of the larger portion of industrial sales.

Non-GAAP EPS was $0.26. Second quarter revenues increased 11% compared to a seasonally low first quarter of fiscal 2023. Revenues increased 6% compared to second quarter of fiscal 2022. Medical revenues were $174 million and Industrial revenues were $54 million. Medical revenues were 76% and Industrial revenues were 24% of our total revenues for the quarter. Industrial revenues have typically contributed between 20% and 22% of total Varex revenues in the recent past. Looking at revenue by region, Americas increased 2% sequentially, while EMEA increased 7% and APAC increased 23%. The increase in APAC sales were primarily driven by strengthened CT. Please note there was a minor reallocation of revenue from Americas to APAC in Q1 of fiscal 2023.

China continues to perform well for us with sales of 17% of our overall revenue for the quarter. Let me now cover our results on a GAAP basis. Second quarter gross margin was 32% 100 basis points higher sequentially. Operating expenses were $57 million up $7 million compared to the first quarter of fiscal 2023. And operating income was $16 million up $3 million. Net earnings were $4 million and GAAP EPS was $0.10 based on fully diluted 41 million shares. Moving on to non-GAAP results for the quarter. Gross margin of 33% was up 100 basis points sequentially, driven primarily by the larger proportion of sales in our higher margin Industrial segment, as well as reduced freight expenses. R&D spending in the second quarter was $23 million up $3 million compared to the first quarter due to spending on R&D material and Micro-X related payment.

Recall from the guidance we provided last quarter, R&D expense included a $2 million payment for successful completion of Micro-X related technology transfer milestones. Overall, R&D was 10% of revenues at the high end of our targeted 8% to 10% range. SG&A was approximately $29 million up $1 million compared to the prior quarter. SG&A was 13% of revenues. As a note, compared to the second quarter of fiscal 2022, SG&A was up $6 million. The lower SG&A in Q2 of fiscal 2022 was related to a credit associated with our incentive plan. Operating expenses were $52 million or 23% of revenue. Overall, our operating expenses were higher than our expectations due to higher R&D material spend and SG&A. Operating income was $23 million up $5 million sequentially.

Operating margin was 10% of revenue compared to 9% in the first quarter of fiscal 2020. Tax expense in the second quarter was $4 million or 28% of pre-tax income compared to $2 million or 15% in the first quarter of fiscal 2023. We continue to model approximately a 25% tax rate for full fiscal year 2023. Net earnings were $11 million or $0.26 per diluted share, up $0.05 sequentially. Average diluted shares for the quarter on a non-GAAP basis were 41 million. Now turning to the balance sheet. Despite a significant increase in sales, accounts receivable increased by $2 million from the prior quarter and DSO decreased 60 days to 64 days. Inventory decreased $9 million in the second quarter and days of inventory decreased 21 days to 182 days. We are very pleased with our progress reducing inventory, and expect this trend to continue in the second half of fiscal 2023.

Accounts payable decreased by $12 million and days payable was 43 days. Now moving to debt and cash flow information. Cash flow from operations was $27 million in the second quarter due primarily to a reduction in inventory. We ended the quarter with cash, cash equivalents and marketable securities of $122 million, an increase of $14 million from the first quarter of fiscal 2023. Gross debt outstanding at the end of the quarter was $449 million and debt net of $122 million of cash and marketable securities was $327 million. Adjusted EBITDA for the quarter was $30 million and adjusted EBITDA margin was 13% of sales. Our net debt leverage ratio was 2.6 times trailing 12 months EBITDA at the quarter end. Now moving on to guidance, due to an improving supply chain situation for our customers, we are now expecting fiscal 2023 sales to be stronger than we anticipated in the last earnings call.

We now expect revenue for fiscal 2023 to be up 3% to 5% compared to fiscal 2022. Our expectations for the third quarter of fiscal 2023 are; revenues are expected between $220 million and $240 million, and non-GAAP earnings per diluted share is expected between $0.20 and $0.40. Our expectations are based on non-GAAP gross margin in a range of 32% to 33%. Non-GAAP operating expenses in a range of $47 million to $48 million. Tax rate of about 25% for the third quarter as well as the rest of fiscal 2023, and non-GAAP diluted share count of about 50 million shares. With that, we will now open the call for your questions.

Q&A Session

Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions]. Thank you. Our first question is from Larry Solow with CJS Securities. Please proceed with your question.

Operator: Thank you. Our next question is from Young Li with Jefferies. Please proceed with your question.

Operator: Thank you. Our next question is from Jim Sidoti with Sidoti & Company. Please proceed with your question.

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

Operator: Thank you. There are no further questions at this time. I would like to turn the floor back over to Chris Belfiore, for any closing comments.

Christopher Belfiore: Great. Thank you for your questions. Sunny, do you have any final comments?

Sunny Sanyal: Sure. Look, folks in closing, I’m — we’re very pleased with the second quarter results, and we’re encouraged by the demand levels that we’re seeing and our growth prospects for the remainder of fiscal 2023. And as always, I’m very proud of the effort of our global employees that they make on a daily basis. Thank you for taking the time to join us today, and thank you for your continued interest in Varex.

Christopher Belfiore: Thank you, 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 May 16 and can be accessed at www.vareximaging.com/investor-relations. Thank you.

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