Hi, good afternoon if you're on the East Coast. Good morning if you're out West. The next company presenting at the conference is Varex Imaging. With us, we have the CEO, Sunny Sanyal, the CFO, Sam Maheshwari, and the Director of Investor Relations, Chris Belfiore. This session will be a fireside chat, and we'll just get started. Varex is a name that I've covered now for probably about seven or eight years. The company makes primarily components for digital X-rays, both the detectors and the X-ray tubes, with about 30% of their business industrial and the other 70% in the medical side. Sam and Sunny, can you give us an update on China? That was a big issue in the last fiscal year. Sales were hurt by the anti-corruption campaign and also the weak economy there.
What's going on with those, and do you expect those headwinds to subside a little bit in fiscal 2025?
Jim, I'll comment, and then I'll ask Sam to chime in with any perspective from his side as well. Look, what we're seeing is that the bulk of the impact of the anti-corruption campaign that the Chinese government had launched was largely behind us. There's still a trailing effect of that. It hasn't ended fully. They've left behind a longer-term program. There is the effect of some of the slowdowns that we saw that we'll see lingering effects of that. Generally speaking, the buying behavior seems to have opened up. At this point, overall, as we talk to our OEM customers in China, their sentiment is more positive versus negative. We could see some optimism and enthusiasm in their sentiments. As we've said before, we're not expecting a snap back. We're expecting a gradual improvement. We still don't think that it's going to go backwards.
Now, things happen. Things can happen. We expect it to be an ongoing positive traction. At the same time, from the broader economy perspective, the economy, we did not see any economic indicators that give us any belief that there will be any kind of a snap back either. The stimulus program, it seems to be making its way through the economy, but none of our OEM customers in China are able to correlate the increase in demand, their sales, with whether it is just natural, organic, secular demand from the hospitals versus anything to do with stimulus. There was really no one who could really pinpoint and said, you know, in this province, it was a result of the stimulus. They all acknowledged that the stimulus is directed towards upgrading of equipment, and that should be a positive thing.
The timing and effect of when that will really have an effect still remains unclear.
Okay. Another issue last year was that some of your OEM customers would destock, and they had built up a lot of inventory during the prior year because of all the supply chain issues that were out there. As a result, they delayed some ordering. Is the inventory at your large OEM customers, do you think that's back to normal levels? Do you think orders come back to historical levels?
We've seen an uptick in the order intake rate. It stabilized during our fourth quarter. During the first quarter, we saw an uptick. That trend for us, as we've correlated that back, gone back to our OEMs and triangulated that for them, it's a clear result of them having pretty much gotten back to their normal inventory levels. We think the destocking event is largely behind us.
One of the issues that seems to have come back with the new administration is tariffs. I know you dealt with this in 2018. Can you talk about any potential impact on tariffs this year? Are you in a better position than you were in the last time when tariffs came up?
Yeah, let me start there with that last part of the question. Versus 2018, 2019 timeframe, we feel we're in a more robust position in terms of being able to deal with it because we have a more diversified supply chain. In 2018, it was all about our suppliers in China. We had created a large base of suppliers in China, low-cost suppliers. Now, since then, we've qualified alternative suppliers in Europe and in other parts of Asia, like India, for example. We feel we're in a better position to withstand the effect of tariffs. In terms of operations as well, our operations in China are much farther along, and it's pretty much self-sufficient for what we need to do in China itself. When I say self-sufficient, I mean we do send parts into China. We have exemptions for those.
What we make in China, we have a much broader portfolio of what we make in China for Chinese customers. We are in a better position operationally. At that same time, if you look at where the competitive intensity is high for us, which is in detectors, we have full capability to make detectors in the U.S., in Germany, and in China. That puts us in a good position. Lastly, with India coming online fairly rapidly in the near future, very near future, we will start to see manufacturing. In fact, in the third quarter of this year, we should start to see manufacturing of detectors in India. The factory is already up and running. We are going through the regulatory approvals for it. That gives us yet another alternative to be able to supply detectors globally from India. We are in a better place.
We've also done our analysis and assessment of the cost impact of the tariffs. When you look at the direct purchases, what we buy in the U.S. from suppliers from outside the U.S., like China, the impact of the direct impact of tariffs on the direct purchases is not significant at this time. That's one part of it. The second part of it is, well, what about the indirect? What we buy from U.S. suppliers and then their suppliers and their suppliers, that we're trying to still understand and assess the impact of because that's very tough. Most of our suppliers don't have a good line of sight to all the entire depth of their supply chain. What we are expecting is we'll see some of that in the form of cost increases from our suppliers.
At this point, our intention is to pass that on to our customers. We are doing what is needed from an infrastructure perspective so that we can track that and be able to account for it and to be ready to take advantage of any duty drawback programs or any other opportunities for gaining exemptions that we might be able to get. Our strategy is three-pronged. One is make locally wherever it makes sense to avoid all these problems to begin with. We will seek out exemptions where feasible, where possible, where exemptions are made available. We have confirmed that the exemptions that we get in China are going to continue. The new retaliatory tariffs did not have any implication on our products. On the U.S. side, the exemption programs, the old exemption programs are in place still.
There are no new exemption programs yet, but we have begun the process. We will go for exemptions first. Second, we will see if to the extent that we have alternative suppliers, we will switch to alternative suppliers and redirect the supply from those alternative suppliers to avoid any tariffs that might impact us. Thirdly, the rest, we will pass through. That is the approach we are taking.
You mentioned a new plant in India. How long did it take to get that plant up and running for detectors? When do you think you'll be able to supply the X-ray tubes from that plant?
Yeah, let me ask Sam to respond to that. Sam is in the middle of all of that.
Sure. We are building two plants in India, Jim. One is for detectors and one is for tubes. The plant for detectors, we are expecting to start supplying products from there towards the end of fiscal 2025. We have been working on getting that up for almost a year now. The plant for tubes has a little bit more construction and more work to do with it. Actually, we have been working on that now for more than 18 months. That plant is expected to produce towards the end of fiscal 2026 for us.
Do you think the products made in that plant, will they be sold primarily in Asia, or will those be available worldwide?
Initially, our strategy is to produce in India for global consumption, depending upon the customer location and customer preference. Eventually, we believe the India market will grow, and we should be, and we hope to be able to supply India market demand from those plants. Initially, our approach is India production for global consumption. In the tariff situation, like Sunny was saying, tariff world, it does provide us a good option to provide products from India for certain products where we can avoid tariffs because India generally is more in a neutral situation with many countries. We are hoping that the tariffs can be avoided if we are able to produce from India. We will have to see.
All right. We'll switch gears a little to the photon counting technology. I know this is a technology you started investing in, I think, about four or five years ago with the acquisition. How are the products based on this technology going on both the industrial and the medical side?
At a summary level, Jim, we sell about $20 million-$25 million worth of photon counting detectors currently, and that's increasing. The uptake has been, as we had expected, much more rapid on the industrial side, as it tends to be. There are less regulatory hurdles and other things to go through. Our big play in the photon counting space is on the medical side, particularly with medical CT. In medical, in general, we have seen a lot of interest across many different modalities. We are engaged with our OEMs as they design new modalities or new applications with photon counting. We will see that, such as in different forms of radiographic or mammography or a bunch of offerings. That's sort of, I'd call it, our ongoing typical OEM medical business. Our main focus has been photon counting or CT.
CT detectors is a new space for us, new addressable market. There, as we mentioned in our earnings call the last time, which is we've got one global OEM that is fairly solidly on track with their plans, with their programs, with their R&D plans and ours as well, working with them. They've got launch dates in mind. They're marching towards that. We're working with a couple more OEMs that are in sort of the different stages of the sales process. One is further along than the other one. That's so far the progress that we've made that I can call out. It's hard to get into any more detail than that because these OEMs are extremely sensitive about their plans and what they're doing. We'll continue to keep our investor base updated on progress as we feel appropriate when we reach certain milestones.
What's the advantage of this technology over the technology, the traditional technology used on detectors?
The benefit of photon counting technologies, particularly in CT, is first and foremost, very high resolution imaging, high resolution, high contrast imaging at a significantly lower dose. That is sort of to start with. That's sort of the baseline. Secondly, with the technology, the way it is, the way it's designed, it enables very much more precise material discrimination. In the longer-term clinical applications can be designed where they potentially could cross over into other modality areas with better soft tissue resolution, areas that cross boundaries of different kinds of imaging applications today. That's sort of the longer-term holy grail of this technology, better use of the material discrimination capabilities.
All right. One of the areas where your business has accelerated recently is cargo inspection. You made a decision to supply complete systems, whereas in the past, you were selling primarily components. What was behind that decision?
Jim, first, as a background, this is an area that we're very familiar with from a technology perspective and also overall ability to develop and implement systems. Long back, we used to make the full systems. We still do have a lot of systems installed between the U.S.-Mexico borders that were designed and implemented by our company when it was originally part of Varex a long time ago. It is not a brand new area for us. We know this space. That said, recently, a few years ago, as we started looking at the space, particularly during the downturn post-COVID, we saw that there was a gap. Now, as we look at the overall market space, we see it as being very large, very active. There is quite a bit of opportunities.
We decided to re-enter the space with our full systems because we were already selling full sub-assemblies. We sell the X-ray sources, the linear accelerators. We sell detectors. We sell the software for acquisitions. We decided to go into it ourselves with full systems offerings. In addition to selling the equipment, the ongoing value for being in it ourselves directly is that we also get to access the services side of this space that is also a pretty substantial opportunity.
As tariffs are implemented with Mexico, do you think that will spur demand for these types of systems?
I think two things are spurring demand for these types of systems. One is the world has become less secure, and there's just ongoing conflict everywhere. That's number one. There is quite a bit of demand from a security standpoint. Secondly, yes, with tariffs, the fact that also these linear accelerators are capable of very good material discrimination, it allows for applications. By the way, our customers have been using our linear accelerators to do this, where they use the technology to compare what's in the container versus what's in the manifest. If the container says it should be potatoes, and if it's something else, it looks like something else, that's one particular use of this technology, which now with tariffs, potentially that becomes a more important feature. We haven't seen a direct correlation between tariffs. It's too new to tell, too early to tell.
What we are seeing is that there's a pretty substantial demand for these systems, and there's a lot of tender activity. Now, we have our brand. For us, we have the competency and the capability. Our brand is very well recognized and respected. Our technology, it's installed in over 1,500 sites globally. Customers know that we have deep domain knowledge in this space. We do get visibility to the tenders. The receptivity in the market has been good. We are one of the only two players that are fully vertically integrated in this space. That makes us a very good player in this space.
All right. Another area where you've made some investments, another new technology, is the nanotube technology. I know you have agreements with a company called Micro-X now. Last year, you announced another agreement with Nanox. Can you tell us how far you are in the development cycle for these types of products? I guess start off with what's the advantage of using this technology?
Yeah. So nanotube-based X-ray sources are a way to build X-ray tubes where you don't need a heated filament. Imagine this is like a solid-state X-ray tube. The old vacuum tube-based electronics versus solid-state transistor-based electronics is a similar analogy. Now you have the cold cathode, which can turn on and off without the need to be heated, more just like a semiconductor. It can be switched on and off to very high speed like you would with semiconductors. The advantage of that is you can build X-ray tubes with multiple emitters that can be switched on and off very rapidly. Using that technology, you can significantly simplify imaging applications where there might be movement, and you don't need the movement.
Like in a mammography system, when you take 25 projections, and to do that, you have to move the whole gantry, or in a CT where you have to rotate, or in a C-arm. There are applications where there are opportunities to dramatically simplify, speed up those systems using this type of technology. That's the, at a 50,000-foot level, the potential benefits of this technology. Simplification means cost reduction. Simplification of the hardware means you could conceive new images in a way that might not have been practical previously because of geometry or mechanical motion, things like that. That's, in a nutshell, the benefit of this type of technology.
Where we are with it is that the technical feasibility of both the technology itself being used to generate X-rays, our ability to manufacture them, the life and all of the sustaining, whether this technology can sustain itself, can we make it in scale, will it withstand the demands of X-ray imaging. We are satisfied with that. We've had quite a bit of work already done over the last four or five years to establish technical feasibility. We're at that stage now where we are getting OEMs to understand this. We are shipping prototypes to them so they can characterize this and play with this. There's quite a bit of interest in it, largely from a lot of the smaller OEMs who are trying to envision highly differentiated new applications. This technology is further behind in terms of market adoption readiness versus photon counting.
It will be a few years behind photon counting in terms of our seeing new OEMs bring this technology to market. That said, by the way, we're done with the technology transfer with Micro-X. That's all done in place. We are in full independent development and production mode ourselves. We did announce that partnership with Nanox, that's our typical OEM customer. We have an agreement to make tubes for them. That's moving along well.
I mean, it seems to go on the same theme, though. It's better images using lower power. It's similar to photon counting.
Yeah. Our stick with this is that the combination of nanotube-based X-ray sources and photon counting gives the world an opportunity to make really, really interesting, novel imaging applications. We, as Varex, have both those technologies together.
Okay. Another trend in your space is artificial intelligence, AI. I know GE, they just announced yesterday, I think they're using AI for ultrasounds. They announced a deal last year. They're using AI with their smart mammo systems. Are you investing in AI? And do you think this will be a trend that will be helpful to Varex?
Our investment in AI has been through our MeVis business unit, which is we own 73% of shares of MeVis. Our foray in it is twofold. One is in AI applications in lung screening. We have full-blown workstations, and we're bidding in tenders going directly to end markets where there are country-level tenders. We've talked about our wins in Canada, and we're bidding on tenders, lung screening tenders in other global markets. At this time, we have plans to continue to incorporate AI technologies in other application areas. We haven't disclosed publicly some of those, but we will continue to work with those AI applications using the MeVis resources and their competencies.
All right. I'll give Sam a chance to ask a question on the balance sheet. When I first picked up the company, there were talks about violating debt covenants. Things have just improved dramatically over the past few years on the balance sheet. I know you did another refinancing a few months ago. What are your plans now regarding debt pay down and the overall debt structure?
Sure. Thanks, Jim. We did a refinancing, or actually, we did an add-on bond for $125 million. It is recorded on our balance sheet as restricted cash. We plan to leverage this $125 million and also remaining cash from our balance sheet to pay down the convertible note. This is our intention. Final decision has not been made towards this, but we are getting close to that decision day. Within a few months here, we need to pay down the debt. That is the direction we are headed. With that, we would have taken care of the convertible by paying it down with cash from the balance sheet and not to convert the convertible or refinance the convertible into a new convertible. Okay? Secondly, in terms of gross debt, the remaining piece would be the one high-yield note that we have.
It's currently at about $370 million total notional. Our plan would be, with our excess cash over time, to pay it down somewhat, a little bit. Ideally, I would like gross debt to be in the $325 million-$350 million range. In terms of total leverage ratio or net leverage ratio, rather, as a factor of adjusted EBITDA, we would like it to remain, we would like it to be maintained below three. Currently, we are around two and a half, somewhere around that. We have some room. We would continue to have a conservative financial policy in terms of maintaining low leverage ratio. Our business should have some leverage, Jim, as you know, because we have a decent amount of revenue, which is recurring revenue. Within our recurring revenue, there is a decent piece, which is replacement of service-oriented revenue.
From a capital perspective, we should have some debt. Ideally, I would like it to be in the $300 million-$350 million range.
Right. You've invested in India. You've made some investments to build up inventory in past years. What do you think this year looks like in terms of cash flow? Do you see an uptick in capital spending? Do you see an uptick in working capital spending? Or do you think you'll get cash from working capital in fiscal 2025?
Yeah. We do not guide in terms of cash because, as you know, cash can be very volatile. However, if you look at our historical performance, typically from net income, adjusted net income to cash flow generation ranges between 80% to 120% in that range, 0.8 to 1.2. I do not expect anything that is going on in this year that would change it. That is in terms of the overall way we look at the year. It is true, you highlighted about our investments in India. FY 2025 is a significant year of investment in India for us as we get these factories up and running. CapEx is expected to run close to $30 million for fiscal 2025 and also run a bit heavy next year, which is fiscal 2026.
Once these two years are passed, we should come down to our natural CapEx rate of, say, $20 million-$25 million a year, below 20s. That's what has been our natural CapEx run rate. We should come down to that beyond the two years of slightly higher CapEx.
Right. I think we have time for one more. I just look at your business. You've had a couple of major headwinds. The anti-corruption campaign and the destocking issues have at least normalized at this point. You seem to have an opportunity in cargo inspection right now. It does not feel like it is at all reflected in the stock. I mean, the stock is near its lows for the past couple of years. What can you tell investors? What do you think is happening to give them confidence that you are past these things and that you think the company is in a good position going forward?
Jim, let me again, I'll ask Sam to complement or supplement my response. A few things. First of all, we are seeing an order intake rate improvement, which gives us confidence that the destocking is that phenomena was industry-wide, but that's behind us. Number one. Number two, we're seeing our sentiment on China is, I'd say, more on the positive side versus neutral or negative. We expect to see that continue to improve. The prognosis, we've talked about. Thirdly, the areas where we are investing, there are three areas that we're investing in that are all $100 million type of opportunities for new areas. We are playing India is all about radiographic to gain share back in radiographic. We expect that to be a $100 million type of a product line. We talked about photon counting.
By 2029, we expect the contribution from that to be in the range of $150 million. The third one, cargo, we expect that to be also a $100 million-plus type of revenue contributing segment or product line over the strategic planning, this three to five-year horizon. Those are three big areas where we are seeing positive traction in every one of those areas. Radiographic, it is in our domain. It's up to us to get the factories is getting there very in short order. It'll be up and running. Even before that, we'll be able to ship those new radiographic detectors from Salt Lake City. That's in our control. Cargo, we're playing actively, heavily. We've talked about some wins. We've talked about several installations that we've made. There is traction, ongoing progress, and we'll continue to give visibility as we win deals.
Photon counting, that is the longer play because it's a more complex modality like in CT, CT detectors. The good news there is once you're designed in, even though it takes a while, once you're designed in, it's a 20+ year type of a play. That is what excites us. I don't think that's reflected in this talk.
Do you think it's just concern over the tariffs? I mean, because it feels like you are in a much better position than you were six, seven years ago.
There's always the fear of the unknown that I think continues to plague us with, whether it's tariffs, whether it's China. We've talked about our position in China being strong because of the way we are designed in. There was concern about China 2025 world. We're halfway through 2025. We've always said that we've made plans with our Wuxi operations and production. Thirdly, in terms of the tariffs themselves, the direct, we've said the cost impact of that is not significant. Secondly, in the retaliatory tariffs that we've seen from China, they do not impact the healthcare products. Even what we have in place is going to continue to receive exemptions. I do think it's a little overdone for us. Certainly, the selloff that we saw after earnings call was not warranted in that sense either.
Look, I'm disappointed that the stock hasn't reflected all the good things that we're talking about here.
All right. The next earnings call feels like it's just around the corner again. I'll be looking forward to talk to you, get an update on these issues, and see how things played out in the second quarter.
All right. Thank you, Jim.
Thank you, Jim.
Thank you for the time today.
Thanks.