The next company to present is Varex Imaging. With us, we have the CFO, Sam Maheshwari, and the Director of Investor Relations, Chris Belfiore. This presentation will be a fireside chat. I have a list of questions I'd like to get through, but we may have some time at the end. If we do have time and you have some questions, you can type them into the Q&A box at the bottom of your screen. Let's just start out with the basics. First, welcome, and thank you for presenting, Sam and Chris.
Thank you, Jim.
Can you just give us a brief summary to people who maybe aren't as familiar with Varex on what your two main business units are and what you do, what you sell and who you sell them to?
Sure. Thanks, Jim. Thanks for inviting us. Varex has been in the X-ray business. We provide X-ray components, and we've been in this business for more than 40, 50 years. We are focused on X-ray-based imaging, X-ray and X-ray only. We sell our products in two segments. One is medical and the other one is industrial. In medical, we are generally running around 70% of revenues, and industrial is about 30% of our revenues. We predominantly sell X-ray tubes, X-ray detectors, associated software, and then also some other smaller components that are deployed in the broader X-ray systems. We sell to almost every medical imaging OEM out there in the world. We believe there are roughly 150 of them.
Almost all of them, maybe a few that may not be, but almost all of them are our customers. We really pride ourselves in having very, very long-term relationships with our customers. With many of these customers, we've been in business ongoing for the last 30, 40 years. Customers like GE, Siemens, Philips, Canon, Hologic, all of these are our customers on the medical imaging side. On the industrial side, we sell to companies like OSI Systems. We sell products to Zeiss, we sell products to Thermo Fisher and a lot of other companies in that space.
All right. The first question I want to ask you is on tariffs, and you've dealt with tariffs since the first Trump administration. Can you just tell us a little bit on what you've done to mitigate the impact of tariffs, and can you talk about where you are now after the recent Supreme Court decision?
Yes. The IEEPA-related tariffs went last April. Since then, the first step that we've done is that we've been passing the increased cost of tariffs to our customers. I would say we have been successful at that. We've been passing increased costs to our customers since then. Obviously, it takes a little bit of time because it goes into the inventory and then it rolls through, but that's what we've been doing. At the same time, we've also continued to push more and more of our, what we call local for local manufacturing, in the sense drive more production of our products that are sold in China to our factory in China.
Similarly, we have factories in Europe, and so we are driving a little bit more production for European consumption to our factories in Europe. That's one thing we have done. We've been developing a local supply chain for these factories in different countries. We've also been working on bonded warehouse, et cetera, some tariff mitigation type of approaches that are allowed under the rules. That's what we've been doing. The biggest benefit has been through passing the prices to our customers. With the Supreme Court ruling now, these tariff rates have gone down, but the higher tariff rates, Jim, are still in our inventory, and they're still rolling through.
The lower tariff is definitely a positive for us. It is directionally a positive phenomenon or event for us. We really like that. It'll help us in the long run once these higher tariff costs from the inventories are rolled through, and it should provide a little bit of benefit to our P&L, maybe in, say, four to five months.
Okay. Yeah, that was my next question, is how long do you think it takes to turn that high-cost inventory over? About four-
Yeah, I would say four to six months.
Okay. Can you just give us an overall description of what the business environment is, especially on the medical side? You know, I know there was an issue with extra inventory in the channel. Is that back to normal levels? With regard to hospital capital spending, you know, is that back to normal levels as well? Things keep changing, you know. With this recent geopolitical issues, has that had any impact?
Yeah. From a broader market and demand perspective, some of the things that we look at is a discretionary procedure volume and then also the hospital CapEx environment. Both of those metrics are stable. The hospital CapEx environment is in a good place. Within that hospital CapEx environment, we look at certain surveys, and we look at what is the priority for imaging in the upcoming one year or two years for the hospital CapEx. Generally, imaging is amongst the top 3 priority areas because it is a very high profit center for the hospitals. From that perspective, imaging runs either top or number 2 or number 3. It continues to be that way.
I just a few days ago I read another survey, and that's, th e macro demand situation, it's stable for us. It's stable and growing. Coming back to your question in terms of the recent turbulence and all of that, generally, our experience has been that whenever there is any recession or any turbulence, healthcare does reasonably well, and then our business typically does not get that much impacted by some of these turbulences typically. Of course, during COVID, it was a healthcare-driven crisis, so we did get impacted. As we study 2008, 2009 crisis, et cetera, our revenues weren't really impacted a whole lot because people still fall sick, and people still need to go see the doctors, et cetera. From that perspective, so far, we are continuing to see stable to slight growth type of a situation for us.
We're monitoring order intake rates. Order intake rates have been stable and have been nicely improving. Your first question actually was around the channel, inventory in the channel. That we had talked about, that phenomenon being completely behind us almost a year back. That is now squarely behind us. We were right on it when we called it out that the inventory that the channel has a bit too much of inventory due to supply chain crises previous to that. That has pretty much all worked its way through. There was also another issue, Jim, that was going on in China about a year ago when they were auditing their hospitals, and that was dampening the hospital purchase behavior in China.
That's also squarely behind us at this time, and we are beginning to see stable to slight improvement in procurement out of China for us, for the medical business.
You talked about some of your big customers, the GEs, the Canons, the Hologic's. Are they developing new systems, and are you working with them on those systems? You know, how does that pipeline look?
Yeah, I would say that's actually a pretty good development in the last couple of years during COVID and for a few years after COVID, that new system development process and steps and velocity that had kind of taken, I would say one gear down or two gears down. That has picked up in the last one or two years, I would say. That is really good for us because that's when we design our new products into their new systems. The activity has improved. We are really excited about it. Our engagement with them has only gotten stronger in the last one or two years. We are quite excited about that.
All right. You know, one of the drivers in the past for you has been the transition from analog to digital on the imaging side. I assume that's pretty much complete in the United States. Are there other areas of the world where they still use film, where they're still transitioning to digital?
Yeah. I guess you're referring to the medical detector side. Medical imaging driven by detectors. Yes. I think, Jim, you're right. In U.S., Western Europe, Japan, et cetera, that transition is pretty much complete. All of the films are gone, and everywhere they are using digital detectors. There are still areas where people are using films, particularly, I would say, South Asia. Certain Latin American countries, you know. There is, I would say, BRICS countries, Brazil, Russia, India. There is some of that still in China and Indonesia, et cetera. There are countries with reasonable size of population where film is still a reasonably decent size of overall imaging market, so to say. We are continuously looking forward to that conversion from film to digital detectors. Yeah.
Was that one of the reasons for the new plant in India? You know, I know that plant, it started out making detectors. You know, how is that going, and is that starting to ramp, are the shipments starting to ramp out of India?
Yes. I would say that is one of the factors. There were a number of factors why we decided to go and produce products in India. As you know, we are building two factories in India related to radiographic products. One is for tubes, and the other one is for detectors. The radiography segment is more of a value segment, is a very price-sensitive segment of our business, and a subsegment of our medical segment, so to say. You know, we have very good products in that subsegment. However, our price was a bit too high compared to our competition out of Asia. We've been losing a bit of a market share in that subsegment in the last few years.
With the help of Indian manufacturing, with the quality of imaging that our products provide, we anticipate that we would be able to compete very effectively out of our production out of India, and so that we hope to gain our market share back in the medical radiography business. That's one. Secondly, like you just said, in some of these newer areas where more and more digital detector demand will grow in the coming years, they are also somewhat of price-sensitive countries or geographies. It is very important for us to be cognizant of that and have products that these geographies and patient population can actually afford. That's kind of the reasons why we decided to produce radiographic products out of India.
That first plant, is that ramped up to, you know, production at this point? Is that running at capacity, or do you still have room to go there?
The first factory which is related to radiographic detectors, that factory construction is complete, validation is complete, and we are beginning to sell detectors made out of that factory already. We are selling detectors produced in that factory within India, and then also exporting out of India for global radiographic consumption. However, I would not say that that factory is anywhere close to full utilization. It just started. As you know, in our industry, we have to go through regulatory steps, and it takes time. It is slowly improving its utilization levels, but it is very. I would say currently its utilization is low, but it is growing. We are looking forward to more utilization out of there.
We are working with our customers and customers to qualify and get new orders and new business, and then feed it through our India factory to grow our top line and then also increase the utilization for that factory. The second factory in India is, I would say, towards the later stages of construction process. That factory is expected to be completed by the end of this calendar year. We are about 10 months away from completion on that. That would be something to talk about from a revenue generation perspective with calendar 2027.
Okay. All right. If we switch over to the industrial side, you know, you've put up very strong numbers the last several quarters there especially, cargo inspection systems. I think you reported about $55 million in sales of a new system that you released in fiscal 2025. What's driving that demand? Do you expect it to continue in fiscal 2026?
Yeah. You know, we've been selling linear accelerators or components for the security inspection business for quite a long time, last 20-30 years. About 18 months ago, we started releasing products and started to solicit business for the full cargo systems. The reception has been very well-received by our customers. One thing to keep in mind is because of our previously existing linear accelerator business, all of the end customers know us. The Varex brand is very well known. When we came out with the cargo systems, the full systems, it was very well accepted. Now we are participating in all the tenders. We are winning.
We booked $55 million in FY 2025, and we hope we are successful, and we book more in FY 2026. Now, generally, book-to-ship timeline in that business is less than 12 months. Say six to nine months is book to ship. From ship to service is about another 18 months or so. That's the timeline of that business. I wanna make sure, Jim, was that your question, or there was something else within that question that you wanted to ask?
Well, that was part of it, is really what's driving the demand for those cargo inspection systems?
I see. Yeah. Right now, all the countries or many countries are trying to secure their borders more. Everybody is trying to do a little bit more of inspection on their cargos that are coming through their ports. Wars and all of these things, they are driving more and more of a need for more safety and security and more inspection on the borders. That's number one. The second one is also the tariff-driven environment where the governments are trying to see, the customs agencies are trying to see what is inside the container and compare it to the manifesto that has been declared by the importer and making sure everything is right because different products have different tariff rates.
If you are bringing in hemp and cotton, and if they have different tariff rates, then they want to make sure that the manifesto is being done right. It is driving more of a need for inspection. Then based on some studies that we've done or we've looked at, believe it or not, we believe still only 10%-12% of overall cargo is inspected worldwide. It is not close to 100% at all. There is still a lot of expansion for inspection opportunities here in this business.
All right. You know, I know initially when those systems shipped, it might be, it might not be accretive to margins, but generally when service starts, the service revenue is accretive to margin. How does that, you know, how is it gonna work for Varex? When do you start getting service revenue on those systems that you're shipping now?
Yeah. Generally, service is very accretive to our gross margins. Generally, industrial overall is accretive to the corporate gross margin, and then the service business from the cargo systems is accretive to the industrial gross margin. It is at a much higher gross margin. Typically, service begins to accrue after the warranty period is over. I would say book to ship is six to nine months, and ship to service is about 18 months of installation and warranty time. That's generally the timeframe. You could say two years in total, plus or minus a few months from booking certain business to start having the service business.
Okay. All right. Can we switch over to one of the new technologies, something you've been working on, I think for about four or five years now since you completed an acquisition. It's the photon counting technology. What's the main advantage of using that technology?
There are a number of advantages. In photon counting, first of all, it is very fast. With the help of photon counting, we can take 10,000 frames per second type of X-ray based imaging. Now, generally, X-rays used to be a slow imaging technology, but you can see the inside, and you can almost make a movie out of it. That opens up a number of industrial applications, fast-moving specimen type of applications. For example, a cereal box, hundreds of cereal boxes or cereal boxes moving across the finished goods line at a very fast pace. You can also imagine envelopes in a postal sorting center.
You know, so many envelopes are getting sorted out, packages, parcels, all of that. Applications open up. EV batteries where each cell needs to be inspected. In food area where, you know, chickens going through the line, and they wanna make sure there's no metal inside it, or fish where they wanna make sure there are no bones inside it. All of these things can be enabled because of the speed of photon counting. With the help of software, you can see if there is something inside it that you don't want. Mascara bottles that the brush is completely straight and it is not hooked or whatever, something like that. All of those things, they're finding novel ways of applying photon counting technology.
That's driving on the industrial side. On the medical side, there are a number of benefits. Biggest one is dosage reduction. You can get a better image with 70% less dosage. Particularly in CT, because in a CT application, the tube rotates around the patient's body, and there are many exposures that are taken. In a CT image situation, there's a lot of dosage of X-rays that's applied to the patient. There, photon counting can cut it down by 60%-70%. That's one. Secondly, there is material discrimination capability because you are counting in a way every single photon.
Basically, every single photon that is going through your body, and as it goes through skin versus ligament versus the bone or heavy contrast type of an item, its energy on the other side of whatever it is imaging is different, and it'll see that, and then it'll create an image accordingly. That is what, in very simple terms, what we call it enables material discrimination. I'm speaking in a very non-technical, simple manner, Jim. The technical guys can spend hours on this. Whereas in general X-rays, it would just be X-rays, and then on the other hand, all you were looking at is what came out and what didn't come out. You know, through the bones, stuff won't come out, but, so t hat's how it was being done.
Photon counting enables a much higher quality image, which provides a lot more information to the medical practitioner, along with a significant dosage reduction, and it can also do it fast. In that way, it is the next generation of technology. Everybody is talking that it has a lot of benefits to it. It's just that it is much more costly. Cost is the only element where it does not score well compared to the existing X-ray technology. But on all the other parameters, it does really well.
As you indicated before with the new factories, it takes a while for things to be adopted on the medical side, approvals and such. You know, what do you think the timeline is now for systems to actually be using this technology to be out in the field?
Yeah. Our R&D teams have been working with two customers and their R&D teams. Now, with one of them, our work is largely done. They are working on their system side. On the second one, we are in the mid stages, so to say. The first one we expect should be releasing their system in calendar 2027, early calendar 2027. They generally do not like to share a whole lot of details with us. We get our revenues when they release their system and when they go into production. Because for every one of their system, they would want one of our detector. These detectors are expensive, you know. In medical space generally, we sell components that at the top end are, you know, $75,000, $80,000, $100,000 a piece.
These detectors in photon counting CT, that space would be more around $250,000 a piece. You can see even 20, 30, 40 units can add up very quickly for us in terms of unit count. We have two customers, and then there are a number of other customers that we are working with in terms of getting to a finish point where they can decide to say that they want to go with us, so that process is also ongoing. We've also started to work with other non-CT type of customers to get into non-CT medical applications, to get our product in non-CT applications as well. CT is the main driver of growth because that is where the highest value add is from this technology.
All right. I wanna make sure we get this one in. You know, since you've joined, Sam, the balance sheet has gotten much cleaner. You had some, I think, pretty significant news early this week with the refinance. Can you just review what you did, and you know, what your current debt levels now are, and what do you think the impact of that refinancing is?
Yes. Thank you very much, Jim. Yeah, that has been a focus area for me. Right now, our total debt is $350 million. After this financing, I would say our capital structure is very simple and clean. I have one debt, which is a term loan, high-yield debt term loan. Its tenor is five years. We were able to reduce the coupon rate from our previous debt, which was about 7.875 coupon, and this one we are bringing it down to close to 6%, so pretty significant rate reduction. As part of this refinancing, we paid down $18 million of debt, so we de-leveraged a little bit more, as part of refinancing.
One of the key things that I wanted to make sure that in this refinancing we preserve is an ability to prepay. Right now the P&L, you know, we are investing quite a bit in our business in both R&D for cargo inspection and photon counting, and then also in India in terms of manufacturing, expenses, and then also building these buildings and capital expenditures. P&L is going through a lot of investments, and the balance sheet is going through, I would say, less than what we target in terms of cash flow conversion. Once these turn around and we begin to generate revenues through these initiatives, we should really improve our operating leverage, our EBITDA margin, gross margin, EBITDA margin, and then also cash flow generation.
It was very important for me to ensure that when that happens, we have the freedom and flexibility to pay down the debt that we have. In this new refinancing, we have no prepayment penalty.
It sounds like once these factories are complete and the photon counting systems are out in the field, you should see a jump in free cash flow.
That's the goal. That's the target. That's what we are working towards. Absolutely.
Okay. All right. I think we're just about at time. Last question is, you know, when you look out to fiscal 2026 and beyond, you know, what are the things that you think are the most exciting, and what do you think are the things that are the most concerning?
Yeah. Let's cover the exciting pieces first. On the exciting side, the three things that I talked about, photon counting, cargo inspection, and the India initiative. We are getting not exactly in the same innings, but in all of these games we are getting towards the later stage innings. They will get completed and ramp up at different timelines, each one of those. We are getting towards the finish line, so to say. That is really exciting that we turn these around and begin to kinda experience revenue growth and then the operating leverage expansion as a result of these activities. That's really exciting for me, the go-forward. Then I have set up the balance sheet and the capital structure accordingly.
That's exciting for me in the next year or next couple years. In terms of what I'm worried about, I guess I have to say the volatility and the uncertainty in the policy environment is something that is very difficult to keep our arms around. That is always something that keeps us up, you know. I know I'm not the only one. Everybody's facing it. Yet, whatever the policy is, how it applies to you, and what mitigative measures I would need to take on my business is always that my brain is always working on at the seventh gear, and that is always an area of concern or an area of anxiety.
Okay. All right. Well, great. We are at time, so I just wanna say thanks again, Chris and Sam, for presenting. I guess we'll be talking again soon. I mean, it seems like there's always another quarter right around the corner, you know.
Yes. Thank you, Jim.
All right. Thank you.
Thanks for supporting. Look forward talking to you. Thank you.
All right.
Thanks a lot, Jim.