Sunny Sanyal - President, Chief Executive Officer Clarence Verhoef - Chief Financial Officer Howard Goldman - Director of Investor Relations.

Greetings! And welcome to Varex Imaging Corporation, Second Quarter Fiscal Year 2020 Earnings Conference Call. At this time all participants are in a listen-only mode. A 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, Howard Goldman, Director of Investor Relations. Thank you. You may begin. .

Good afternoon, and welcome to Varex Imaging Corporation’s earnings conference call for the second quarter of fiscal year 2020. With me today are Sunny Sanyal, our President and CEO; and Clarence Verhoef, our CFO.

To simplify our discussion, unless otherwise stated, all references to quarter are comparisons to the second quarter of fiscal year 2020 versus the second quarter of fiscal year 2019. On today's call we will discuss certain non-GAAP financial measures.

These adjusted measures are not presented in accordance with nor are they a substitute for GAAP financial measures. We provided a reconciliation of each adjusted financial measure to the most directly comparable GAAP financial measure in our earnings press release, which is posted on our website.

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.

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 statement in this discussion. And now, I'll turn the call over to Sunny..

First, we forged long-standing relationships with our global OEM customers. It's not uncommon for us to have customer relationships that exceed 25-plus years.

These customers, particularly our largest customer who drove the vast majority of our growth in CT tube sales during the quarter, all continued to win in the market with systems that include our advanced and cost effective technologies.

Second, our leadership in innovation drives new technology adoption and our global OEM customers continue to rely on Varex for their future product needs. Despite disruption in operations from the pandemic, most of our OEM customers continue to move forward with their CT system introduction plans.

Third, the scalability of our operations is an advantage that our customers value. As I previously mentioned, some of our customers saw an uptick in demand for their systems that was driven by COVID-19 and we were able to fulfill most of this demand during the quarter.

While the dental, mammography and oncology markets appear to have slowed down globally due to the pandemic, we firmly believe that this is a temporary situation for us. These are markets where we are well known as an innovation leader and OEMs have responded very favorably to our recent product introductions.

Despite the pandemic, there has not been any notable slowdowns in the rollout of our new detector technologies such as our high performance and cost effective Z platform for dental, surgical, cardiovascular and other dynamic applications. Customer projects in these areas are moving forward.

At the same time we have continued to make solid progress with our plans for introducing locally made radiographic and dental detector products in China and have begun shipping these products in increasing quantities.

Our new portable wireless detector is currently one of the lightest and the most robust detectors in the world, with best-in-class specifications and we're very encouraged by the traction that it has received from OEMs developing mobile X-ray systems.

In summary, we feel very confident that our medical detector and tube technologies are hitting the mark, and we expect to come out of this temporary pause competitively stronger than before. In our industrial segment, a decline in world oil prices led to significantly lower sales of products for our cargo screening at ports and borders.

Most projects of this type are typically tender driven and funded by governments, many of which are located in all producing regions of the world. Similarly, in the NDT market, product sales to our customers in the oil and gas vertical decreased substantially as spending contracted sharply.

Product sales for other NDT applications also declined considerably due to the global economic impact of COVID-19 on many companies that manufacture commercial and consumer products.

In the second quarter product sales for airport security market increased; however, given the precipitous drop in global air travel due to COVID-19, we anticipate a decline in product sales for this application in the second half of this fiscal year.

Despite temporary headwinds we continue to believe that the industrial segment remains an attractive part of our business with long term growth potential.

Overall, the COVID-19 pandemic and its impact on the global economy has created a disruption to Varex’s business, which includes significant uncertainty in demand for certain products for our medical and industrial applications, as well as variability in our supply chain and manufacturing productivity.

We expect this uncertainty to continue for at least the remainder of the current fiscal year. As a result, we're withdrawing our previously issued guidance for our fiscal year 2020.

To help improve our financial condition and better enable our business to weather the extraordinary challenges associated with COVID-19, in the second quarter we initiated a series of cost reduction and cash preservation measures that will continue into the second half of our fiscal year.

For example, we have pulled in the closure date of our Santa Clara facility by full quarter into the fourth quarter of the current fiscal year. In the United States we are reducing labor costs through furloughs and targeted reductions in personnel.

In addition, for the remainder of this fiscal year, through a combination of two weeks of leave without pay and temporary salary reductions, we will be reducing cash compensation for our non-production employees by approximately 10% to 30% depending on the job level.

My salary will effectively be reduced by 30%, and other members of our Board of Directors have agreed to a 30% reduction in their annual cash retainer for the second half of this fiscal year. Internationally, we're exploring and implementing salary reductions and reduced work schedules, each in-line with local guidelines.

We're temporarily suspending the company's 401K match along with cash components of Employee Recognition Programs. We have reduced and will continue to reduce other discretionary expenses, and we're taking actions on low margin products in our portfolio to either increase prices or discontinue the products.

In aggregate, we expect these actions to reduce costs by approximately $15 million to $20 million over the remainder of this fiscal year. There are other long term actions under evaluation as well.

We're targeting additional cost reductions across our entire business as we look closely at the broad portfolio of our product lines, assets and facilities, as well as our overhead cost structure. We expect to begin implementing these changes in the second half of 2020.

The leadership team and I are committed to delivering on this and we will provide additional details over the next few quarters. With that, let me hand over the call to Clarence to talk about our financial performance in greater detail. .

Thanks Sunny and hello everyone! Before I go into the details of the second quarter performance, I wanted to discuss liquidity. The cost actions that Sunny just reviewed are for two purposes, they will help to improve the P&L performance and they are critical for cash preservation. We have recently taken other actions to manage your cash as well.

Several months ago we put a hold on all capital equipment spending, other than that what was needed to increase production for high demand products. We continue to target reducing inventory levels while managing our manufacturing build schedule due to the frequently changing customer demands.

We are closely monitoring our customer payment patterns and negotiation with our suppliers on payment terms. We are taking additional steps to strengthen our balance sheet. At the end of March we modified the covenants of our credit facility to increase the allowable leverage ratio to 4.25x adjusted EBITDA.

In April we borrowed the remaining balance of our credit facility that provided us with an additional $65 million of cash. We're in the process of pursuing other sources of capital, including the U.S. Government Main Street Lending Program.

Now turning to the quarter, we had good revenue performance while both gross and operating margins were weighed down by segment and product mix, and some one-time events. For the second quarter revenues were $197 million compared to $196 million in the prior year quarter.

Medical revenues for the quarter increased $6 million to $155 million and industrial revenues decreased $5 million to $42 million. For the second quarter our gross margin was 29% compared to 33% in the prior year quarter. Medical segment gross margin declined by about 3 points.

During the quarter we incurred one-time costs of approximately $2 million related to a customs audit in Europe and approximately $1 million of accelerated depreciation related to the closure of the Santa Clara facility.

Industrial segment gross margin decreased by about 4 points versus the prior year, due to an unfavorable mix of lower margin products. Overall our adjusted gross margin was 32% compared to 34% in the prior year quarter, primarily due to lower volume and performance in the industrial segment.

R&D expenses were $21 million in the second quarter, an increase of $2 million from the prior year quarter, primarily due to the inclusion of direct conversion. As a percent of revenues R&D expense was about 11% for the quarter.

Second quarter SG&A expenses were $35 million and included approximately $4 million of expenses related to acquisition integration, restructuring and other non-operational costs.

SG&A expenses also increased approximately $3 million versus the prior year due to audit and consulting fees associated with the implementation and remediation of new accounting standards. SG&A expense for the prior year quarter were $30 million and included approximately $6 million of expenses related to restructuring and other non-operating costs.

Depreciation and amortization totaled $11 million for the second quarter compared to $8 million in the prior year. As mentioned previously, the second quarter included $1 million of accelerated depreciation related to the closure of the Santa Clara facility.

Our operating earnings for the second quarter were $1 million compared to $14 million in the year ago quarter. Our adjusted operating earnings for the second quarter were $11 million compared to $23 million from the year ago quarter. Interest expense in the second quarter was $5 million which was comparable to the year ago quarter.

In April we completed the payment of deferred consideration for the acquisition of direct conversion, which was based on a fixed amount of Varex shares. Due to the reduction of the Varex share price in the second quarter, we revalued the amount of the deferred consideration and recorded a one-time $3 million gain in other income.

This gain is excluded from our adjusted net earnings. Tax expense for the second quarter was less than $1 million compared to tax expense of $2 million in the prior year quarter.

We recorded a net loss of $2 million or $0.05 per diluted share in the second quarter compared to net earnings of $6 million of $0.15 per diluted share in the prior year quarter. Adjusted net earnings for this quarter were $5 million or $0.12 per diluted share, compared to $13 million or $0.34 per diluted share in the prior year quarter.

Diluted shares outstanding were $39.1 million shares versus $38.5 million shares in the prior year quarter. Looking at our working capital, accounts receivable increased by $4 million during the quarter. Day sales outstanding was 59 days compared to 57 days in the prior year quarter.

Inventory increased $13 million in the second quarter to $282 million, primarily due to additional inventory in preparation for the transfer of detective production from Santa Clara to Salt Lake City. We ended the second quarter with cash and cash equivalents of $24 million.

During the quarter we increase debt by $2 million and ended the quarter with total debt outstanding of $383 million. Due to the uncertainty associated with the COVID-19 pandemic, we have withdrawn guidance for the fiscal year 2020.

That said, directionally we anticipate that the decline in revenues in the industrial segment will continue through at least the end of the fiscal year. Now I'll turn it back over to Sunny for some closing comments. .

Thank you, Clarence. Before we get to questions, I'd like to emphasize that despite the significant near term headwinds our business fundamentals remain strong. We will continue to support our customers, we will continue to innovate, and we will continue to take actions to ensure that Varex is well positioned into the future. Varex is unique.

We have been a leader in the X-ray imaging industry for more than 70 years and we continue on – plan to continue that leadership for the next 70 years and beyond. We're a leader in both innovation and quality and our customers recognize that. We have many multi decade long relationships with customers who rely on Varex for their imaging system needs.

We believe there will be continued long term demand not only for X-ray tubes and detectors, but for Varex’s X-ray tubes and detectors. We supply approximately 25% of all X-Ray tubes and digital detectors globally, and are the only independent manufacturer of both these products in the United States. Thank you for your support.

This is an unusual time and we will not only get through this, but emerge competitively stronger. We will now open it up, the call for your questions. .

Thank you. [Operator Instructions]. Our first question comes on the line of Anthony Petrone with Jefferies. Please proceed with your question. .

Hi! Great! And good afternoon. Hope everyone's doing well and staying healthy and thanks for the update. .

Hello Anthony!.

How are you Sunny? Just one quick housekeeping question, just on the $2.1 million add back to gross margin.

Just a little bit of color there on that in particular and then in terms of orders specifically from the China backlog, anything you can provide in the way of CT tube demand this quarter and how that will trend into the back half and then I'll have two quick follow-ups. Thank you. .

I’ll let Clarence take the first one and I’ll take the second. .

Yeah Anthony, I'll answer the – what's going on with the add-back there. So this is related to the customs audit that's going under way in Germany in particular, and so it's one of those things where we've booked some estimated amounts for the prior year customs payments associated with that.

We are contesting it in the courts, because there's been a ruling down by the customs authorities about which classification for our detectors or for any detectors for that matter that are being imported into Germany and they've chosen a classification code that has a higher tariff rate than what we’ve historically used.

And so this is going to be a bit of a process that will take some time to get resolved.

I would say it's going to go through the courts process, and I expect that we will probably end up booking a little bit more around that in the coming quarters as we get further clarity from the auditor in terms of the more recent time periods and all locations that we have in Germany..

Okay. So again, would you expect you know two point around that $2 million sort of add-back to be repeated, you know possibly next quarter and then trail off into the back half or will sort of fluctuate from here. .

Yeah, it’s – I'm going to take an estimate that says yes, that we would expect to see another number, whether it's in the next quarter or the next two quarters or something like that, a similar size kind of number to that. Hard to define exactly, because the auditor still has to finish their work around it.

So it’s all about identified numbers versus kind of rough estimates and at the time we only booked the amount that's clearly identified. .

Got it. .

Hey Anthony….

Yeah, thank you. .

Second part of your question, China orders, how things are going there? So CT and China have been the bright spots to this quarter and I'm very happy to say that there – you know things in China are rebounded back fairly quickly.

They were down for six, seven weeks and when they came back, things returned to normal fairly rapidly and then the CT, out CT performance in China came right back to where in line with the trajectory that we were on. So we are very satisfied and happy with what's going on in China.

And CT in general was a good performer for us, it was a combination of two things. One, our normal run rate for CT continued on and things progressed as we had anticipated, and in addition to that we had additional demand during the quarter, tied to COVID-19 related purchases.

That's – you know we anticipate that that was used for assisting and diagnosis of COVID-19. So we had a nice bubble of CT during this quarter that we were able to deliver against, but the foundational demand there was in line with our expectations. .

Okay, and then two quick follow-ups. Sunny you mentioned obviously headwinds in dental, in particular and we've heard obviously on our end lots of checks on the decrease in procedures and physician office closures. And then you also you know referenced the oil market, so headwinds in the medical imaging space but also industrial.

How do those two play out when you think about orders into the second half, but also backlog? Is there a risk that the backlog gets impaired to the spend on these headwinds?.

I'll start with the demand side. As we – as I mentioned, for the second half of year we expect strength in CT to be as any other year as normal.

CT just seems to have its own demand paths and it’s a very versatile modality and when people have the choice of buying multiple modalities and they have to pick one, it's usually CT, and so we are benefiting from that.

Then that said, the other modalities, dental, mammography, you know as you’ve seen in the market, those came to a grinding halt as physician offices stopped performing procedures and they stopped coming into the office.

So we've seen that stoppage, but our – we're seeing external signs of dentist offices opening up, but those haven’t translated into straight demand for us yet, but we believe that as soon as these outpatient clinics open up, that we should start getting back to those kinds of volumes.

Timing is a bit uncertain; is it next quarter, is it two quarters from now, that's where the uncertainty is. We are talking to our customers, dental customers, mammography customers weekly, daily and looking for signals.

Since we are on the front end of the supply chain in this, we expect that we will get earlier signals than – you know we're treated usually three months ahead of their production shipments, so we hope that we will be the first ones to know as demand comes right back there.

We've seen dental demand in China come back, which is – and if the other markets are following that similar pattern, we would expect that physician offices once they open up then these outpatient related system purchases will begin, resume.

And then, I'm sorry, for the late last part of your question regarding – I didn't get the question… [Cross Talk].

Yeah, just that you mentioned oil in terms of the security detection business, that segment of that portfolio included in industrial. Just you know how that's playing out just in terms of demand for security detection, linear accelerators and you know more so of the backlog of that business is now at risk. .

Yeah, in general we don't carry much of a backlog. As you know we usually, it takes our lead times for delivering products anywhere between 90 to 120 days. So there's no real significant impact to any backlog or impairment to any backlog. What happened in that segment of our market is that two factors played in.

One, because of COVID-19 many of securities projects just came to a stop, because people couldn’t show up there to do the installations. So that’s why – that was number one pause for the slowdown.

Again, we are on the front end of this, so we felt probably a part of it, and then our customers who deliver those systems and install those systems felt the actual impact of the delay. But the delay also caused then other projects to ship or move out, so that's why we saw a slowdown in cargo related shipments during the quarter.

The second part of this is oil prices. Oil prices usually have a slowing down effect on tenders that come out. So this business is largely tender driven and projects where we were expecting tenders to come out, where our customers were, you know they all moved to the right, so that's a number two reason.

And related to that, related to the oil prices, we have a good solid presence in the oil and gas vertical, in our industrial business, and there as oil prices came down, the willingness to spend money also shrank. So we think that that oil and gas for industrial tubes, detectors and software will be tied more to those oil prices than COVID-19. .

Okay, I'll get back into queue. Thank you. .

Thank you. .

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

Great, thanks. Good afternoon guys. Hope everybody is doing okay. .

Hi Larry. .

I just have a few question, a couple of follow-ups. Just on – clearly you know your COVID impacts obviously started in China and what not, but probably for most of the quarter you didn't feel much of it until you know the later, probably two, three, four weeks.

Just trying to – I know you are not giving guidance, but just trying to get from a high level, trends in April, you know in terms of sales and stuff have they, just you know a bed in some areas and others been, like you said in CT remains kind of constant.

Just trying to get some of kind of feel or maybe even tell us what happened in the first quarter in terms of front half versus back half. .

Well Larry, I'll start out with a little bit. First of all, I'm going to give you the reminders. Yes, we don't give specific guidance anymore, and I can't probably give too much color around this.

I think the key point though is that around the industrial side of the business, the slowdown that we saw you know and it started you know probably midway through the second quarter, not necessarily just the last few weeks of it, because you got to remember we’re more on the front end of the cycle as Sunny was just mentioning.

And that slowdown in industrial, all indications are that that's continuing on and our expectation is the second half is going to see more of that. .

And I suppose it’s gotten worse, right, at least during the last week right, I mean….

I'm not going to get very specific, but yes I would say that you know the – because if you're thinking about it as you know we had a slowdown in the second half of it, that means we still had an okay first half. And so just recognize that you get a full quarter's worth of impact on this now rather than just a month or a month and a half of it.

And then within the medical space, you know I mean I think Sunny has already touched on a little bit about CT demand continues on, the radiographic detectors and kind of the products that are used for doing some basic chest X-ray kind of imaging. That demand is still there.

So I mean I think it’s – and it's more about the additional capital equipment purchases for higher-end applications that we’ve seen a bit of a slowdown in the latter part of March and going into the next quarter..

Right, and then just in terms of – just not to look back too much, but in terms of the Q2 performance, because it's probably where undoubtedly you set out in an increasingly more challenging world.

But in terms of margins, the impact on mix, was that mostly just the drop as you mentioned, the industrial side, because I would think that in the medical side at least some of these, you know the CT machines I know you have pretty good margin on right so in the tubes, right. .

Yeah, let me – yeah, you know Larry, I’m glad you asked that. Because I looked at it as kind of in a little bit more, maybe a little bit more macro in terms of we ended up at 32% as our gross margin. We've been targeting for the year to be 35%, which was comparable with a year ago or the prior year.

So three points of loss margin is a pretty significant movement for us, and I’d break it down roughly a third, a third, a third into three categories. The first of it is overall mix, whether it's between segments or even the mix of the products that we are selling.

We are just selling less of the high-end products in the second quarter than we historically have. The second, and we haven't really touched on this yet, but we still have, particularly when you are comparing with the prior year, we still have the overlap costs associated with the Santa Clara transfer.

So we have some stranded overhead in Santa Clara and we were ramping up production and support costs in Salt Lake City in preparation for the transfer. So that's you know roughly a point of impact as well.

And then let's not lose sight of that COVID by itself caused some impact on us in terms of higher freight costs, and just kind of less good productivity in the factories. We are just not as efficient as we were before, and so we saw roughly a point of impact associated with that as well.

You know freight by the way is certainly a challenge and I would say that you see this with other companies as well, is the freight costs have gone up as there's you know restrictions on the number of ships that are available or airplanes that are available and freight costs have increased. .

After that, how much of that impacted your gross margin? And also may be on the operating side, on your SG&A side, your SG&A seems little higher than I through it would. I know you called out the $3 million of increased consulting fees.

So I guess a couple of questions there is that – this new accounting standard, is that more of a one timer just this quarter, is that going to leak into next quarter? And even if I take that out and costs were still I think close to 15% of a decent revenue number, even though the mix was down, that revenue number itself, not so basically was okay.

So trying to figure out, beside those if there’s anything else in there, maybe some COVID related stuff. .

I’ll only kind of run through kind of the different elements of that, and I would put it first of all as far as the added consulting costs to do the new accounting standard, most of that was associated with an accounting standard that was implemented in combination of Q1 and that bled over a little bit into Q2, so we had that.

That’s you know probably – you know I talk about $3 million and that’s probably at least $2 million is associated with that. We also if you remember, we said the SOX remediation costs, we used to non-GAAP that out and have now started to include that in our adjusted earnings, our adjusted financials.

So there is you know some additional cost associated with that, that historically has been adjusted out from a non-GAAP adjustments perspective.

And then, you're right, I think that in general, just a little bit of you know less good performance in terms of the overall business, because the COVID, I have a hard time putting a lot of that into the SG&A bucket, so I didn’t incur a whole lot of extra costs associated with COVID.

It is more that we just haven’t been operating as efficiently as we would normally like to. I missed one other point, which is particularly when we are doing a comparison with the prior year, we do I have the addition of direct conversion, which adds mostly on the R&D line, but it does add some additional costs on SG&A as well.

And we are not generating the revenues yet with the direct conversion. So there's a bit of a – let’s call it investment in that business going on right now that still impacts us from a SG&A as a percentage of revenue perspective. .

Longer selling cycle, I guess. Just last question I guess and Sunny kind of touched on, you know hopefully a lot of this stuff is temporary or oven come back next year, hopefully in a couple years were you know it's pretty much under control.

I guess my question is, a lot of your stuff on the medical side, a lot of your purchases are -- a lot of its driven by high-end CT machines and stuff.

If these hospitals, even if there are likely surgeries, you know they’ll come back, but maybe not quite to the part of where they were and in the meantime can get to A-to-B maybe in some of these hospitals; their funding is a lot lower.

So is there a possibility where you know the economic impact and maybe the direct impact of slowdown or lack of surgeries lead to slower equipment sales for an extended period, that would then you know impact your OEM on you guys. .

I’m going to give an initial response and then I want Sunny to answer that more, because I think he has a better finger on the pulse of that.

I would say that you know the question was a little bit about you know what will happen with hospital economics, and I think that's an interesting question because I – you know from what I’m reading and kind of what I'm hearing a little bit is, is that there’s a lot of more interest in making sure that hospitals are viable and hospitals are properly funded and the like to ensure that they are functioning well.

So I'm not sure I agree with your premise, that you think that they will all have – that they'll be struggling more in the future. I think that there’s a commitment by governments to make sure the hospitals function well.

Sunny?.

No, it’s not a premise. I just wanted to hear – I’m just trying to play devil's advocate and that you know it's a theory that they will be struggling, but you know I appreciate your thoughts there. .

Yeah, and Larry I think that your theory I think translates into a timing uncertainty and that's why you know we're not – because we can't put our finger on the specific timing of recovery, we’re withdrawing guidance. But fundamentally, if you think about it, let's take oncology as an example.

Demand for cancer treatment, we just don't see that diminishing. So you know things like oncology, mammography, dental procedures, these are going to come back, because the basic demographic drivers that will continue to be there, and the question is, will we see a faster return on the ambulatory or versus the hospital, we just don't know those.

Secondly, a pretty significant portion of our revenues on the tube side are replacement tubes. So you know as hospitals come back online, as CT systems continue to function, if that demand comes back. There was some of that demand that slowed down as well when just you know things – surgeries stopped getting done.

So we're more – we’re bullish that the fundamental market drivers will then bring the systems, you know this demand side back online and the timing is, but we're not placing a bet on. .

I appreciate the color. Thanks a lot guys..

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

Good afternoon everyone. Sunny, Clarence, Howard, hope everyone are safe and healthy..

Thank you..

Can you hear me alright?.

Yeah..

Okay, so Sunny and Clarence, let me just kind of dance around between some questions. Sunny, one of the things that most of the companies in our universe, albeit these are correlated to procedures in hospitals and the hospital’s shut down obviously has a collateral impact, most of the companies that we know of have been telegraphing.

Look, April volumes were down anywhere from 50% to 85%. Now obviously you guys as businesses are a little different, you know not only for a medical and industrial perspective, but just sort of the visibility you have in demand, ordering patterns and so. I'm not sure I heard any specific numbers on how you'll saw April, maybe early May shape-up.

Would you'll give us some color that you know this is where or maybe even oil and gas, this was where it was down this much and you know relative to what you'll normally see pre-COVID. .

Well Suraj, I think I talked a little bit with Anthony about this, which is I'm just – I would say that the industrial side of the business is we saw the slowdown that starts in the second or the middle part of the second quarter and now we expect to see a full quarter's worth of that decline.

So you can a little bit do the math around that in terms of extrapolating what a half a quarter’s decline is versus a full quarter's decline.

I'm not going to probably give very specific numbers, somewhat because you know we still do our business pretty much without a lot of back log and so with a lot of orders as they come in and then we ship and deliver to that demand. .

Got it, okay. Sunny, in terms of you know again, how should we think about contractual minimums if any. You know what offsets are there? You guys are going to get impacted, right, everyone is getting impacted, but how should we think about any contractual minimums over the next, let's say three quarters.

You have to tie this calendar year, you know that could give us some perspective of okay, here is a counter balancing effect despite some slowdowns let’s say in oil and gas. .

So Suraj, I think we've said this before that our agreements with our customers, our pricing agreements and the prices are volume driven, so there are really no – with a few exceptions where we may have done special projects and you know – but generally speaking, there are no real hard and fast contractual minimums.

These are mostly – if volumes are down, then next year when we sit down to talk about prices and/or sit down with our customers, we’ll have a discussion around pricing, but largely speaking you know customers don't take more than what they need and if they take more than what they need, then next quarter we have a – you know they take less.

And so you're not going to see an impact of that from us. We don't have any significant adjustments because of any volume adjustments. .

Fair enough, so no offsets, okay. And Clarence, in terms of Santa Clara, any change in time lines in realizing. You know is it still on track for calendar ’21? Any additional color or has some things been delayed because of COVID. .

No, actually – and I first of all just want to say kudos to the team, because there is a ton of work going on right now in terms of ramping up the capabilities to do that, manufacturing those detectors in Salt Lake City, building the initial production of those, having those go to our customers, having them validate that they perform well, and that we’re right in the midst of that right now.

We will start to see the slowdown, the ramp down of the Santa Clara operations at the end of this quarter and going into the fourth quarter, so we start to see some financial benefit in the fourth quarter of this fiscal year. So we have moved that in about a quarter from what we originally talked about.

So instead of talking about end of the calendar year, most of the production will have been stopped by the end of the fiscal year. So we pulled it in about three months from there. So it means that we fundamentally will get the full benefit of reducing those costs for all of fiscal year ‘21.

And so pretty much on track and I would say you know I mean there's a lot of work to be done. There's always a few hiccups and learnings along the way, but I would say all-in-all that they are on schedule. .

Fair enough. And final question and I'll hop back in queue. Sunny, forgive me; I've just been jumping in between two calls.

So as we map out the remaining quarters, would it be fair to say that the relative impact of the structural drop in demand, oil and gas and the CapEx spend thereof is going to impact you guys more than on the medical side or COVID related, specifically more – you know I'm just trying to visualize how the medical line item would map out of the per forma models versus industrials.

Is it safe to say industrials, we should pretty much factor in all the step-down, predominantly in the industrial segment? Thank you for taking my questions and be safe everyone..

Yeah, hey Suraj, that's actually a pretty difficult question to answer, but let me see if I can frame it for you. The behavior in the industrial segment is different by vertical. So as you know we play in security as a vertical. Within security we've got airport and you've got cargo.

What's happening – and I'll go through examples of a few articles, so you can get your sort of a framework around this. If you look at the security vertical, airport security related issues are tied to both. You know volume – for us it's tied to volume of passengers going through airports.

As more passengers go through airports, more systems are used and more demand for tubes, right, that's number one; that's COVID related.

Now, our other customers in security that are in cargo related security, there yes, they've had some delays with projects getting delayed, but there the demand you know comes from being able to pay for these and if these are in oil producing countries, oil based economies, then the projects move out.

So it's a combination there in security, but mostly this COVID related stuff is temporary and the oil related stuff will continue to – we've seen this happen in the past when oil prices go down, projects get delayed. Hopefully the project funding will come back when the oil prices stabilize.

In other verticals, if you look at let's say verticals that are more broad based manufacturing and consumer facing. So the food inspection vertical or electronics inspection vertical, these are tied to COVID and these are tied and recovery there will be tied to consumer spending and when these factories open up and production start, right.

Then you've got verticals that are in the government sectors, like aerospace. There we think we are optimistic, that the government will continue to spend money according to their budget. So there – that recovery is on a totally different track. It’s based on government funding and government budgets.

So every – and oil and gas where we were selling software detectors, tubes, that vertical is again tied to oil prices. So there isn’t one single reason for the recovery. We think in industrial we’ll be staged.

You know some things will come on earlier as manufacturing, general manufacturing comes online, and other verticals will start to resume there, as they resume their operations we’ll see recovery, so full recovery time frame is hard to put a finger on. .

Our next question comes from a line of Mark Strouse with JP Morgan. Please proceed with your question. .

Yeah, good evening, thank you very much for taking our questions. Just wanted to get a bit more color on the cost savings.

When you talk about $15 million to $20 million in cost savings during the second half, is that versus prior plans? Is that a year-over-year number? Just any color there and then also how much that would be in COGS versus OpEx?.

I’ll take a shot at that. So Mark its, it would be against our current run right. So the first half run rate, you would say these are reductions that are happening against that current run rate. So that's probably the easiest way for you to model it. And you know a good portion of that is people related kind of expenses.

So we kind of walked through – you know Sunny walked through some of the different actions in terms of furloughs and salary reductions, etcetera. So those are going to be spread more in the R&D and SG&A lines, because we are not impacting the direct labor of production.

So you're going to see a heavier weighting up those people related costs in the operating expenses than you would in the gross margin. At the same time we're looking at some of our, let's call it variable expenses inside of the manufacturing overhead, and reducing some of those as well.

So that's where we do see some benefit with that, and you know a subset of that is with the pull-in of the Santa Clara closure. We see that benefit mostly in the gross margin line, a little bit in the R&D line. So a bit of a mixed bag.

I would say probably in the order of magnitude of two-thirds operating expense, one-third gross margin, very roughly speaking..

Okay, that's helpful Clarence, thank you. And then I wanted to go back to your long term gross margin targets.

You talked about expectations for the market to eventually recover, but are there any structural changes that you think come out of this that might impact that long term target?.

Well, I’m going to give you a little bit of color form the finance guide and then I think Sunny can give a little color on kind of the broader picture kinds of things.

But you know, as we learned through this process about how can we function with reduced cost structure, like the things that we just talked about here just a second ago, there's opportunities there that say these could be things that could continue on, maybe not so much the furloughs and salary reductions, but more about some of the other operational costs and variable expenditures, etcetera, so that's a fundamental starting point.

And then, you know we're going to take a hard look at just our overall cross structure as we kind of look at our overhead expenses, some of the – some of our lower performing product lines and say should we – what can we do to either discontinue those or get some level of price increase.

Those are the things that make a difference from the gross margin perspective. At the same time, you know we continue to invest on the right things in R&D with the – you know we talk about the new Z platform for detectors, that’s a big deal for us.

I mean that is one of those that will end up actually – you know it’s improving the performance of the product and has a good cost structure associated with it. So it does lead to some better performance in the detector side of the business with things like that. .

Okay, very helpful. Thank you. .

Sure. .

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

Good afternoon. It's good to hear you guys. I hope everybody’s safe..

Hi Jim!.

Hello Jim!.

So just a couple of quick follow-ups.

I just wanted to make sure about what you said, in China are those manufacturing facilities up and running and is that business back to where it was before COVID?.

Jim, this is Sunny. I'll start off. So China has recovered fairly quickly from – at least from the COVID related shutdowns that they had over a period, they came right back fairly rapidly on track. And so our CT projects, our factory projects, the production work, the starting up of our production, all of those has remained on track.

We're producing detectors in China, we are shipping them in increasing quantities, we are making RADs, radiographic detectors, dental detectors, oncology detectors, all that’s – our plans for China remain on track, so that’s – you know we are very happy about that. .

And in addition we had begun to move. Remember we talked about moving some of our – some portions of our supply chain and qualifying suppliers in China, those are also on track and we're using those suppliers in our manufacturing activity that's going on in China right now. .

Okay, and then in your other facilities worldwide, have you cut back on shifts and can you tell us you know a percentage on how much you cut back if you have?.

No, actually we didn’t, we didn’t. There was no cutting back on shifts, etc,. The only place where we had challenges was in the Philippines and there was a period of time when production staffing went down, dipped because of the transportation issues.

We created dorms for our employees in the facilities, we housed them and we production – we balanced production between geographies and look, we talked about this in earlier quarters where we said we're distributing our production globally so that we can be more resilient and that paid off.

Despite a pretty significant impact at a point in time in the Philippines, our on-time delivery of those products, high volume products remained at greater than 99%. So we were able to balance between the Philippines and the Netherlands, added more shifts in the Netherlands and then moving back and added more shifts in the Philippines.

We were balancing labor and shifts and we have been, we've not faltered there. The same thing in Salt Lake City, we've been running at – we were here running at historical capacity levels and we were able to deliver major portions of the increased demand within the quarter..

And how about in the month of April, have you reduced shifts in the month of April?.

I think where Jim has gone is there is a little about, if there is a slowdown in industrial, where we slowed down a little bit of the production, and that would be a little bit in the linear accelerator production for example, is probably the example of that. .

That's correct.

And then our tube production, even the – for those industrial tubes, the linear accelerators are made different, that's a different product, but the regular X-ray tubes, the industrial tubes, medical tubes are made in the same facilities and the labor there is fungible, the resources there are fungible, the production processes are shared.

So that's the advantage of having both those together, we get the economies of scale. .

Okay, all right, so even with the slowdown in industrial, you haven't had to make drastic changes to your production. I mean you're still operating the same shifts you were three months ago. .

Yeah. .

Okay and then my last question Clarence, you talked about the gain you reported because of the final payment to fund the acquisition and the change in share price.

I just wanted to make sure, have those shares already been issued or what should we think about it from a share account for rest of the year?.

The got issued in April and I’m going to go a little bit from memory here. I believe it’s something like 300,000 shares, something in that order of magnitude. .

Okay, so you will still be around that 39.5 million shares..

Yeah, so you’ll get a little bit of dilution here. So that you know, I think we were at 39.1 million, so next quarter we’ll be 39.4 million or 39.5 million, something like that. .

Got it! Okay, alright thank you. .

Yep. .

Thank you, Jim. .

Our next question is a follow-up question from Anthony Petrone. Please proceed with your question. .

Thanks, I appreciate that. Just one on the balance sheet and cash out look. I know that you called out cost reductions in the second half. You do have $30 million due in short term debt and you took out $65 million from the credit revolver.

So just as you think of the cash outlook, specifically I guess looking in fiscal 3Q, it appears that there should be some level of the cash burn. Was there any color there? And as you sort of look into the fiscal 4Q in early next year, will the business be cash flow positive? Thanks..

Yeah, it’s a topic that I spend a lot of time on these days and watching it very closely. Maybe just a little bit of color in terms of our debt. It is that we have a minimum payment that we make on the term loan, that's $7.5 million a quarter. So that's the minimum amount that we have to pay as far as debt payments in Q3 and in Q4.

The good news about our business is that we're dealing with repeat customers that are substantial in their financial strength and that we're dealing with large entities that make their payments very timely.

So we've not seen any changes in the customer payment patterns at this point in time, which is a big deal okay, because as we continue to monitor that, they continue to pay very closely to their terms level.

The key for us is all about, as we see the shift in the mix of what our customers are ordering from us, we have to adjust our manufacturing schedules and we need to reduce inventory for the items that we've seen slowdown in and so that's been the key focus for me.

It is about making sure that we are not having to make payment outflows as such for products that’s just going to sit in inventory. So there's a lot of adjusting going on in terms of our build schedules, and the corresponding purchases from suppliers. That's the main focus that we have.

I would say that the – there’s the obvious benefit that happens with reducing some of the expenses, which is what we talked about the $15 million to $20 million and then also the reduction of the CapEx spending is the other item that helps us keep our cash flow positive for the second half.

It's going to be tight, I'm going to tell you that, it's going to be tight, but I feel like we're in an okay spot. .

There are no further questions in queue. I'd like to hand the call back to management for closing remarks. .

Thank you for your questions and participating in our earnings conference call for the second quarter of fiscal year 2020. A replay of this quarterly conference call will be available through May 26 and can be accessed at the company's website or by calling 877-660-6853 from anywhere in the U.S. or 201-612-7415 from a non-U.S. location.

The replay conference call access code is 137-02-421.

Good bye!.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation.

You may disconnect your lines at this time and have a wonderful day!.

Thank you, guys..