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Edited Transcript of VREX.OQ earnings conference call or presentation 12-Nov-19 10:00pm GMT

Q4 2019 Varex Imaging Corp Earnings Call

SALT LAKE CITY Nov 30, 2019 (Thomson StreetEvents) -- Edited Transcript of Varex Imaging Corp earnings conference call or presentation Tuesday, November 12, 2019 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Clarence R. Verhoef

Varex Imaging Corporation - Senior VP & CFO

* Howard A. Goldman

Varex Imaging Corporation - Director of Investor & Public Relations

* Sunny S. Sanyal

Varex Imaging Corporation - CEO, President & Director

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Conference Call Participants

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* Anthony Charles Petrone

Jefferies LLC, Research Division - Healthcare Analyst

* James Philip Sidoti

Sidoti & Company, LLC - Research Analyst

* Lawrence Scott Solow

CJS Securities, Inc. - MD

* Suraj Kalia

Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst

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Presentation

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Operator [1]

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Greetings. Welcome to the Varex Imaging Corporation Fourth Quarter and Fiscal Year 2019 Earnings Call. (Operator Instructions) Please note this conference is being recorded.

I will now turn the conference over to your host, Mr. Howard Goldman, Director of Investor Relations. You may begin.

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Howard A. Goldman, Varex Imaging Corporation - Director of Investor & Public Relations [2]

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Good afternoon, and welcome to Varex Imaging Corporation's earnings conference call for the fourth quarter and fiscal year 2019. 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 annual comparisons are for fiscal year 2019 versus fiscal year 2018. Similarly, all references to the quarter are comparisons for the fourth quarter of fiscal 2019 versus the fourth quarter of fiscal 2018, unless otherwise stated.

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. Outlook for our net earnings per diluted share is provided on an adjusted basis only. This adjusted financial measure is forward looking, and we are unable to provide a meaningful or accurate compilation of reconciling items to our outlook for GAAP net earnings per diluted share due to the uncertainty of the amount and timing of the unusual items.

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 statements in this discussion.

And now I'll turn the call over to Sunny.

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Sunny S. Sanyal, Varex Imaging Corporation - CEO, President & Director [3]

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Thank you, Howard. Good afternoon, and welcome. Fiscal year 2019 was a good year for us as revenues continued to grow despite a sizable tariff-related headwind while our margins and profitability were consistent with the prior year.

For the year, revenues increased to $781 million from $773 million in the prior year. Medical revenues declined 1% and Industrial revenues increased 7%. Industrial now represents nearly 25% of our total revenues. Gross margins were comparable with the prior year.

Year-over-year, we experienced strong revenue growth from oncology, CT and dental products as well as Industrial Imaging products for airport baggage screening and nondestructive testing. Direct Conversion contributed $6 million of revenue in the second half of the year. Partially offsetting these gains was a decline in digital detector sales primarily due to a tariff-related reduction in radiographic detector sales in China. For comparison purposes, the tariff impact reduced our total revenues by nearly 3%.

Our Industrial segment had a strong year with revenue growth driven by the continued adoption of next-generation technology and digitization of inspection processes across multiple vertical markets. A higher volume of our extra imaging products were purchased for check baggage screening systems at airports as well as inspection applications in oil and gas, food and manufacturing verticals.

Our recent VMI and Direct Conversion acquisitions performed well in the Industrial segment. VMI continues to expand our footprint in the oil and gas vertical by combining their industry-specific software with other Varex products to provide a package solution to customers.

We're also working closely with Direct Conversion's photon counting customers to introduce our X-ray tubes and connect and control products for their imaging applications. The integration of these acquisitions is going well, and we're pleased with their overall performance.

In our Medical segment, revenues declined despite good performance in global sales of CT and oncology products. We experienced lower sales of radiographic detectors and products for the non-OEM aftermarket. Other Medical modalities generally performed in line with our expectations.

Looking at our China business. We saw good quarterly sequential growth in CT tubes during the year, but we experienced a tariff-related revenue reduction of nearly $20 million in radiographic digital detector sales. Altogether, for the fiscal year, 8% of total company revenues were generated by product sales in China.

Our Chinese OEM customers continue to make progress in bringing their CT systems to market, and I'm pleased to confirm that in fiscal year 2019, shipments of our CT tubes to local OEMs more than doubled from the prior year. Consistent with demand from other world markets, about 2/3 of the units shipped were for value and mid-level CT systems.

During the past year, we continued to expand manufacturing capabilities at our facilities in China, Germany and the Philippines. In Wuxi, we're on track to be production-ready for radiographic digital detectors by the end of the calendar year.

In the meantime, our local sales team continues to aggressively pursue opportunities to recapture radiographic detector revenues.

In addition to China, we're also extending our local-for-local strategy to Europe where we continue to expand the digital detector manufacturing in Germany. In addition, we're shifting the manufacturing of other products, such as heat exchangers, to the Philippines where a number of our connect and control products are currently manufactured.

Among other things, these global footprint changes are intended to help us manage the impact of trade war between the U.S. and China. While on and off discussions continue between the countries, I'm happy to report that we received a temporary exclusion from Section 301 tariffs on certain parts and components imported from China into the U.S.

One of our OEM customers recently renewed its multiyear agreement with us for digital detectors and has added X-ray tubes to the mix. We will become their lead supplier for these components and align our production with their imaging system manufacturing centers in Asia and Europe. This is a nice example of the success of our strategy to get geographically close to our customers and offer locally manufactured products. Providing service and support on a local basis was also a contributing factor to their decision.

With that, let me hand over the call to our CFO, Clarence Verhoef to talk about our financial performance in greater detail.

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Clarence R. Verhoef, Varex Imaging Corporation - Senior VP & CFO [4]

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Thanks, Sunny, and hello, everyone. I'll focus primarily on the Q4 results and the fiscal year financials can be found in our press release. After discussion of the results, I'll provide our FY '20 outlook and then Sunny will provide a bit more information on our vision for the future.

In summary, Q4 was another good quarter for revenue while gross margin improvements drove operating profits to their highest level in 2 years. For the fourth quarter, revenues were $202 million compared to $205 million in the prior year quarter. Medical revenues for the quarter declined 3% to $152 million, reflecting higher sales of CT, oncology and dental products that were more than offset by lower sales of products for radiographic, mammography and veterinary applications. Industrial revenues increased 4% to $50 million, mainly due to higher sales for airport security and nondestructive testing applications while sales for cargo security declined compared to strong results in the prior year quarter.

For the fourth quarter, our gross margin was 35% compared to 29% in the prior year quarter. Medical segment gross margin improved by about 8 points over a soft quarter a year ago, which included restructuring charges that amounted to approximately 3 points of gross margin. The remaining improvement was primarily due to product cost reductions and favorable manufacturing variances in the detector business, and to a lesser extent, contributions from the software business.

Industrial segment gross margin improved by about 1 point versus the prior year, also due to the improvements in the detector business. Overall, the adjusted gross margin was 36% compared to 33% in the prior year quarter.

R&D expenses were $19 million in the fourth quarter, a decrease of $2 million from the prior year quarter. For the fiscal year, R&D expense was under 10% of revenues even with the addition of Direct Conversion, which has had a high R&D rate than our organic business.

Fourth quarter SG&A expenses were $35 million and included approximately $7 million of additional expenses related to restructuring and other nonoperational costs. SG&A expense for the prior year quarter were $32 million and also included approximately $7 million of similar additional expenses.

Specifically, in the fourth quarter, we recorded $3 million of restructuring costs associated with the closure of the Santa Clara facility. The project remains on track to cease operations by the end of the calendar year 2020 and to have all closure activities completed by mid-2021.

Depreciation and amortization totaled $9 million for the fourth quarter, in line with the prior year quarter.

Our operating earnings for the fourth quarter were $17 million compared to $6 million in the year-ago quarter. Our adjusted operating earnings for the fourth quarter were $27 million compared to $21 million in the year-ago quarter.

Interest expense in the fourth quarter was $5 million, which is comparable to the year-ago quarter. Tax expense for the quarter was $2 million compared to a tax benefit of less than $1 million in the prior year quarter. For fiscal year 2019, our effective tax rate was 21% compared to 20% in the prior fiscal year.

We recorded net income of $9 million or $0.24 per diluted share in the fourth quarter compared to net earnings of less than $1 million or $0.01 per diluted share in the prior year quarter. Adjusted net earnings for the quarter were $18 million or $0.46 per diluted share compared to $11 million or $0.29 per diluted share in the prior year quarter.

Diluted shares outstanding were 38.9 million shares versus 38.4 million shares in the prior year.

Looking at our working capital, accounts receivables increased by $15 million during the quarter. Days sales outstanding was 62 days compared to 60 days in the year -- in the prior year quarter. Inventory decreased $12 million in the fourth quarter to $251 million.

We ended the fourth quarter with cash and cash equivalents of $30 million. For the fiscal year, we had cash flow from operations of $71 million. We spent $73 million to fund the Direct Conversion acquisition and invest in joint ventures, and we used $20 million for property, plant and equipment.

During the quarter, we reduced debt by $15 million and ended the year with total debt outstanding of $395 million compared to $390 million at the end of the prior fiscal year.

Our outlook for fiscal year 2020 is that we expect revenues to be in the range of $790 million to $805 million, and we expect adjusted net earnings per diluted share to be between $1.30 and $1.45.

To help you with your modeling, we anticipate that our adjusted gross margin will be in a range of 34.8% to 35.3% of revenues, our R&D investment to be about 10% of revenues and SG&A expense to be around 13.5% of revenues excluding unusual items.

We expect interest and other expense to be in the range of $20 million to $22 million, and our effective tax rate to be approximately 22% to 24%.

Additionally, included in our EPS outlook is an impact of approximately $0.05 to $0.07 for overlapping costs related to the transition of operations from Santa Clara to Salt Lake City.

Now I'd like to turn the call back over to Sunny for some closing remarks.

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Sunny S. Sanyal, Varex Imaging Corporation - CEO, President & Director [5]

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Thank you for that, Clarence. Before we get to Q&A, I'd like to take a few minutes to outline some longer-term thoughts for Varex. As we think about how the future may unfold for Varex, a number of things get us excited about our business.

First, we play in 2 large, healthy and growing markets, an established Medical Imaging market and an emerging Industrial Imaging market. Second, we have the ability to out-innovate competitors and provide an advantage to our OEM customers due to our focus as a pure-play X-ray technology company and our R&D investments. Third, our customer relationships, which have lasted for decades, provide us recurring business that give us the potential to be a significant part of their future product releases.

So let's look at each of these areas. First, we get a 360-degree view of the X-ray imaging markets, and we see continued growth in diagnostic imaging procedures and increasing investments being made in health care globally. Developed markets such as the U.S. and Europe are investing in newer systems that deliver better imaging with lower radiation exposure and improved workflow while emerging markets like China and India are making significant national commitments to health care for their people. At the same time, the growing middle class globally is now seeking out cutting-edge dental care, mammography and cardiovascular treatment. We continue to believe that the Medical Imaging market will grow around 3% annually for the foreseeable future with some areas such as CT and oncology growing faster than that.

In China, we're well positioned to take advantage of growth opportunities as expansion of rural health care services and replacement of older CT systems are driving sales growth.

Over the next year, we expect to begin seeing sales of replacement CT tubes for our customer systems shipped during the previous 12 to 18 months. We also expect to see Chinese OEMs beginning to export their CT systems, utilizing our tubes to other global markets.

While the medical market is largely mature, we see the industrial market as a greenfield space that is growing twice as fast as the medical market. Here, we see the potential for our components to be included in new applications in a variety of verticals, such as security, oil and gas, electronics, food inspection, automotive and aerospace.

Our new photon counting detector technology, which enables multi-energy imaging for more precise material discrimination at high speeds, is ideal for real-time inspections, such as those in assembly line settings and food inspection. Over time, we expect this type of inspection to become widely adopted across many industry verticals.

Long term, our opportunity in the Industrial Imaging market could be as big or perhaps even bigger than our currently addressable Medical Imaging market.

Second, as an innovator, we feel confident that our R&D investments in new platforms, such as IGZO, CMOS, photon counting and carbon nanotubes, will enable us to continue to leapfrog and outpace the competition. We believe that in the long run, IGZO has the potential to displace amorphous silicon as the predominant platform for detectors due to its inherent performance advantage and cost effectiveness. Similarly, we see flexible substrates replacing glass in detectors and making them lighter and more robust.

We are now actively engaging with OEMs to introduce commercial versions of these detectors using these technologies. Beyond fiscal year 2020, we expect photon counting and carbon nanotubes to start making their way into innovative applications. Photon counting detectors are capable of imaging up to 10,000 frames per second and differentiate materials more precisely, making them ideal for high-speed imaging applications in Industrial.

We also intend to reinvent how X-rays are generated using carbon nanotube technology. We can envision a future where X-ray tubes will not need heated filaments and be more like solid-state devices that can be turned on and off at high speeds.

Third, our customer relationships are stronger than ever. During the course of the year, our business development activities resulted in several new footprint expansion projects with existing customers. We have a pipeline of customers who are working on bringing 3D imaging capabilities in mammography and dental as well as advances in high-resolution imaging and surgery and cardiovascular.

Our CT tube customers are introducing new systems, which feature cost-effective, dual-energy imaging with reduced dose. We also see our customers reinventing diagnostic radiography with high-definition, 3D and soft tissue imaging. We believe these new platforms will allow us to continue to differentiate ourselves competitively as we bring to our OEM customers significant new capabilities that will enable them to bring more advanced systems to market.

At the end of November, we will be at RSNA in Chicago where we will be showcasing these expanded technological capabilities that I've just outlined. RSNA is the largest trade show event of the year for the medical imaging industry and many of our medical customers will be displaying new products, which incorporate one or more of our components.

In summary, we're well positioned to excel in 2 large, healthy and growing market segments to lead with innovation and to continue to expand our customer relationships.

We will now open up the call for your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Anthony Petrone from Jefferies.

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Anthony Charles Petrone, Jefferies LLC, Research Division - Healthcare Analyst [2]

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Great. And maybe I'll start with a couple on guidance for Clarence and Sunny, both near and long-term guidance. Just as it relates to the gross margin guidance for fiscal 2020, how much of that is coming from the Santa Clara facility being shuttered as opposed to stabilization in the price outlook and/or mix? So that would be the first question.

And the second question on the longer-term guidance, Sunny, would be the comment on Industrial potentially being bigger than Medical over time that's intriguing. I'm wondering, is that organic overall? Or do you need additional bolt-on M&A to sort of see that through? And then I'll have a couple of follow-ups.

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Clarence R. Verhoef, Varex Imaging Corporation - Senior VP & CFO [3]

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Sure. Let me start with the first one, and then I'll hand it over to Sunny. So I think your question was a little bit trying to understand what, if any, the impact is on the gross margin from the Santa Clara facility in the FY '20 guidance. Fundamentally, it's continuing as is because most of the benefit from closure doesn't happen till end of the calendar year, which puts it into our fiscal year '21. And we've got a little bit of a headwind there with the overlap cost. So we're hiring some folks in Salt Lake and adding some expense in Salt Lake to ramp up the activities here as we close down and slow down operations there. And that works out to be something in the order of magnitude of 40 to 50 basis points of gross margin impact associated with that. And beyond that, I'd say that it's -- the rest of it is business as usual for the operations.

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Sunny S. Sanyal, Varex Imaging Corporation - CEO, President & Director [4]

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Okay. Anthony, regarding my industrial comment, a couple of things. We're seeing a very healthy uptake of digital imaging technologies in the industrial space. And it's in a way accelerating, driven by the technologies becoming faster and imaging can be now be done at high-speed in real time while products are being manufactured. And so that's #1. We're seeing adoption increasing in many verticals, right? We've seen -- we've talked a lot about the security vertical. We've talked about oil and gas and food. And what we're realizing as we get into each of these verticals is how profound the potential opportunity is to grow in these segments and the opportunities for new applications. And our learning with the acquisitions of VMI and Direct Conversion is giving us that insight into these verticals.

We've barely touched -- we feel like we barely touched the surface of the potential market opportunity because we're playing in very few verticals. I mean there are lots of other verticals like electronics inspection, like sterilization, like aerospace, automotive where we haven't yet put that type of rigor and focus on. So that's why we feel very bullish that long term, the industrial market will continue to grow, will continue to grow with adoption of technologies. And we feel well positioned there.

Your second comment about, will it be organic or inorganic. The best way for us to get into these spaces would obviously be -- if we wanted to accelerate our entry into these spaces, would be to continue to do small tuck-ins like the VMI acquisition that not only gets us some key know-how or products in the space but also a knowledge of the space, the applications expertise and the relationships and the channels. And we'll -- we keep an eye on these types of opportunities, and we will continue to do that. We just want to make sure that we can -- as we get into any vertical that we position ourselves in a way that where we can be a market leader in that vertical.

And lastly, what we've learned through the VMI acquisition and through Direct Conversion is that there is an opportunity for us to bring multiple of our components together into these spaces. So it's not just about selling tubes or selling detectors, we're able to grow, expand the size of the pie, expand our addressable market by bringing multiple components into this space. We had anticipated doing that with PerkinElmer. And as we've started -- so for example, PerkinElmer had detectors and our intention was also to continue to drive sales of our tubes in the space where our customers are using PerkinElmer's detectors, and we're doing the same things with VMI customers that use VMI software, are now considering our bigger packages with software, detectors and tubes, all packaged together. So that's why we are bullish about the long-term opportunities in the industrial space.

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Anthony Charles Petrone, Jefferies LLC, Research Division - Healthcare Analyst [5]

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That's very helpful. And then just 2 follow-ups would be, again just going back to fiscal '20 guidance. Just wondering if you can give us an idea of what is in there for acquisition contribution at this point. I think there's just a stub quarter for, I think it's VMI.

And then the last question would be just on China OEMs. Just an update on where the order book sits today. I think last quarter was $140 million and maybe how that order book has changed over the past 90 days.

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Clarence R. Verhoef, Varex Imaging Corporation - Senior VP & CFO [6]

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Sure. I'll touch on the first one, and I'll let Sunny kind of give a little bit of further color on the China topic. So it wasn't VMI. VMI actually got closed almost a year ago, a little bit more than a year ago. So it was actually the Direct Conversion that we did in April -- that we closed in April. So we had about 5 months of Direct Conversion in the FY '19 results. And so we get a full year benefit out of that, somewhere in the order of magnitude of probably about $8 million to $12 million is the expectation for the revenue impact from that and a little more accretive from a gross margin perspective. It has a good gross margin profile in that business.

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Sunny S. Sanyal, Varex Imaging Corporation - CEO, President & Director [7]

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So Anthony, just first of all, we don't give orders or backlog information typically. In the past, we've talked about our kind of deals in China, mainly to give a feel for how we're doing in the Chinese market, what the opportunities are. So we had said that we have signed purchase agreements of about $140 million or so in -- with Chinese OEMs. Now that was for -- mainly for CT. Since then, we've continued on with our business development activities.

And as I mentioned earlier, we've seen new projects with existing customers, and we've continued on to grow our presence globally, which includes China. We've continued on with signing customers with -- in several other areas of our products. So our business in China, I would say, looks very healthy, short of the $20 million or so in value rad detectors that we lost because of the trade -- the tariff -- trade war and the tariffs. Short of that, we would have had really nice healthy growth in China. So I would characterize it as our existing customers have continued to do well as expected, and we're continuing to see progress being made by them, and we've continued to leverage our facilities in Wuxi to push the local-for-local type of commercial relationships, and we're seeing nice traction there. And we hope that we will continue to extend that to the radiographic detectors in the future as well and recoup that business.

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Operator [8]

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The next question comes from Larry Solow with CJS Securities.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [9]

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Just a quick follow-up, and then I had a few questions. On the Direct Conversion, just to clarify, so you said $8 million this year on the 5 months and then it would be an incremental $8 million to $12 million next year, so like $16 million to $20 million. Is that right?

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Clarence R. Verhoef, Varex Imaging Corporation - Senior VP & CFO [10]

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I didn't say $8 million for the current year, but it's more -- it was actually around $6 million for this year, a little bit north of $6 million. So -- but the rest of your math is right.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [11]

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And then -- but I thought when you acquired it, its trailing 12-month revenue was $18 million. So why is it lower now?

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Clarence R. Verhoef, Varex Imaging Corporation - Senior VP & CFO [12]

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Yes. I would say that it's not necessarily lower for next year as much as it -- they got off to a little bit of a slow start this year, just in the timing of -- as they're introducing photon counting with new customers and new products, their customers have been a little bit slow in bringing those products to market. A little more than typical that we see in these complex products is there's a fair amount of development work around those. And so that's not had the same growth rate that we had expected in the second half of FY '19 as -- and so at the end of the day though, I think it's got a ton of opportunity in terms of where it's going, and we're very excited about the Direct Conversion business. Photon counting is definitely a technology that the industry is excited about, and we see a ton of opportunity there.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [13]

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Okay. And then just taking a step back, just looking at your revenue guidance as a whole. I know you don't guide per segment per se. But if we sort of take out the -- it's basically like 1% to 3% top line growth and essentially flat to 2% or plus or minus if we take out the Direct Conversion. So organically 0% to 2%. Is the Medical side growing? Because you can almost argue that if you're growing at normal growth rates in Industrial, Medical is probably based on your guidance declining next year, which would be kind of a surprise considering, I assume, China, you'll -- perhaps you should continue to get growth on the X-ray tube side and -- or maybe not. So I think that's a question for you. And then maybe capture some of this $20 million from the -- that you lost from the detectors, even a few million. So I'm just trying to grasp the difference between how to parse out your outlook on the revenue side.

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Clarence R. Verhoef, Varex Imaging Corporation - Senior VP & CFO [14]

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Yes. So the -- you're right, we don't go into the details of giving guidance by segment. But I would say that Industrial is going to have a good year next year. We expect to see some good growth in there. Medical is not declining though. And so I think that's just to make sure that we're understanding that. It's -- particularly because if we look at what are the opportunities that we have, particularly around with CT and where that's going. I think the other part of it though, just to keep in mind is we did not put in much activity for the rad detector recovery, I guess, as such in China yet. I think that's still to be done. And we'll adjust for that if and when it's happening in the future. There's a process that has to happen there to win that business back, and it was not built into the guidance.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [15]

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Okay. So it sounds like organic growth, 0% to 2%, split between the 2, maybe a little bit higher on the Industrial side, I guess. Okay. Just looking back on the -- just on Q4, just a couple of questions on the gross margin. One question was going to be, it increased so much on the Medical side. Some of it had to be onetime in nature, but I guess you sort of answered that question because your outlook for next year is below the level that it was this quarter. So I guess there were some one-timers in there. I know how to comp against one-timers on the negative side, but were there some onetime benefits in Q4 because it seemed dramatically improved?

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Clarence R. Verhoef, Varex Imaging Corporation - Senior VP & CFO [16]

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Yes. I mean, all in all, I'd say we had very good performance in the business in the fourth quarter, and it ended up with a gross margin rate of 36%. That was a nice quarter for us. And we had some very good performance in the factories in terms of the yield that we had, particularly on the detector side. We had some challenges earlier in the year in the Santa Clara operations. And so I think it was nice to see a little bit of that behind us and see just more normal operations there. I am -- I mentioned to Anthony and I'll say the same to you, which is that there is some overlap cost that we're going to incur as we have to build up production as we transfer from the detector manufacturing from Santa Clara to Salt Lake. So that's going to hurt us to the tune of about 40 or 50 basis points. And then -- so that's the biggest thing. And then just being a little bit careful about the risks that we always have in our business relative to product mix is not an insignificant thing that we need to keep in mind.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [17]

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Okay. Just 1 last follow-up since you brought up. Just on the -- so it sounds like you're not getting any benefit this year from the consolidation, which you kind of said on the last call, too. Actually, there'll be a little bit of a $0.05 hit or whatever. As you look out to fiscal '21, you had sort of targeted 20 -- I think $21 million to $27 million in savings. I realize it's not a flip of switch, and you won't get that all in one -- right away. But is that number still attainable? And maybe net a little bit less because maybe some of these expenses that you have to ramp up, maybe those will be sustained?

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Clarence R. Verhoef, Varex Imaging Corporation - Senior VP & CFO [18]

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So nothing has changed in our plans. I think the process is underway. It's a rigorous process to do this. You want to get validation with customers and alike. And so you're right, there's a little bit of a ramp-up that happens to that. You don't get the benefit all in one shot. But we're still comfortable with those projections of the amount of savings that we will get.

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Operator [19]

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The next question comes from Suraj Kalia with Oppenheimer & Company.

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Suraj Kalia, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [20]

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Can you hear me all right?

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Clarence R. Verhoef, Varex Imaging Corporation - Senior VP & CFO [21]

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Yes.

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Suraj Kalia, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [22]

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Pardon the background noise. So a few questions for Sunny and few for Clarence. Sunny, you mentioned X-rays using carbon nanotubes. What is the time horizon on this? Are you at liberty to talk about it now? And I'm really curious in terms of interchangeability because the analogy I have is like a solid-state drive versus a hard disk, right? So I can see what you guys are saying, and that can be a quantum leap. But can you put this within the time framework for us? When is the next product cycle?

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Sunny S. Sanyal, Varex Imaging Corporation - CEO, President & Director [23]

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Yes, I'll take the second part of the question first, which is interchangeability. These are -- it would be a different technology. So you wouldn't be able to take an existing product and just swap out with a solid state -- I mean with a carbon nanotube. Our customers to get the benefit from it would have to build a new application around it. So if you take something like -- I'll use a conceptual example. If you take mammography, mammography, the system is designed to be a moving system and it rotates or turns through a certain angle as it takes the images. With carbon nanotubes, you won't need to have that movement. So the customer would have to redesign both mechanically. It would be a different system. And also, the electronics that drive it would be different. So the way these products will be brought to market and just to answer the first part of your question is, through new product development cycles of our customers. So the time frame there inherently are longer. So there's no real feasible way for me to give you any guidance on the time lines, but it is the typical new application introduction timeline of OEMs, which are fairly lengthy.

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Suraj Kalia, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [24]

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Got it. And I'll just keep 1 additional question for Clarence. Sorry, I'm just trying to keep myself warm here. Clarence, it's freezing, trust me. So Clarence, in terms of gross margins, forgive me, I must have missed your commentary about FY '20 gross margin guidance. Forgive the redundancy, but how should we look upon FY '20 gross margin guidance, especially within the Medical segment vis-à-vis Q4 because the Q4 number was a significant step-up?

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Clarence R. Verhoef, Varex Imaging Corporation - Senior VP & CFO [25]

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Sure. So yes, the -- what I had said is the gross margins for FY '20 would be in the range of 34.8% to 35.3%, that's our estimate at this point in time and our outlook on it. And so that's -- and that's -- you always have the puts and takes that happen in gross margin. So it's going to be things in terms of relative to the product mix that goes on that causes some variation in it. The impact of something like a higher mix that we might have from the benefit of Direct Conversion added in there, relatively small numbers though, but it still has a little bit of an impact. And then if we have a little bit of favorability from a mix of the Industrial side of things, those are things that can be favorable as well. At the same time, you have the challenges that we have, particularly in the detector side of the business, which is price erosion. So we work very hard on offsetting price erosion impact with cost reduction, either through supply chain or through redesign of products. Those are the things that we do that try to keep those things in parallel with each other as such. And so that's where we end up with a gross margin in FY '20 at this point in time similar to what it is in FY '19, I would say a little bit of slight improvement is expected as such. And I mean -- and probably the other big factor is that you're going to have -- you have to be a little bit patient for us to get the benefit from the Santa Clara closure because that's when we're going to get the more significant impact on the gross margin going forward.

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Operator [26]

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The next question comes from Jim Sidoti with Sidoti & Company.

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James Philip Sidoti, Sidoti & Company, LLC - Research Analyst [27]

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Can you just -- I'm sorry if you said this already. But can you just tell me what the revenue from Direct Conversion was in the quarter?

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Clarence R. Verhoef, Varex Imaging Corporation - Senior VP & CFO [28]

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In the quarter, it was around $4 million, $6 million for the year.

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James Philip Sidoti, Sidoti & Company, LLC - Research Analyst [29]

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Okay. All right. And looking at gross margin, it sounds like the benefit from the consolidation will -- won't show up until fiscal 2021. Is that right?

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Clarence R. Verhoef, Varex Imaging Corporation - Senior VP & CFO [30]

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That's a fair way to think of it, yes.

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James Philip Sidoti, Sidoti & Company, LLC - Research Analyst [31]

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Okay. All right. And then with regards to the Medical business, I think you said the shortfall within mammography and the vet business. Is that just timing? Or is there any kind of end-user trends that you're having you can call it?

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Clarence R. Verhoef, Varex Imaging Corporation - Senior VP & CFO [32]

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That's a good question because we -- I'm always a little hesitant about giving too much color on a single quarter because that's a single point in time. I think the annual numbers are much more impactful in terms of looking at things. And I typically want to look at things from a trailing 12 months perspective. So yes, a little bit of the slowdown. And mammo and vet are just basically more dependent on what you're comparing to in terms of the prior year quarter than anything else. The only one that has been consistent for this year is that we've seen obviously the slowdown in the China rad detector business. That's been the one that we saw throughout the year and that's been the impact of tariffs that we talked about. The good news around that is it's finally anniversaried, so we're going to stop talking about it going forward. We won't have to anymore. And hopefully, the conversation is actually transitioning to more of the positive about new business that we gain with that going forward.

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James Philip Sidoti, Sidoti & Company, LLC - Research Analyst [33]

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All right. And then in the quarter, you said the gross margins were stronger than you think they will be next year. Is that a mix issue?

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Clarence R. Verhoef, Varex Imaging Corporation - Senior VP & CFO [34]

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No. It was much more about operational, about good performance in the factory, low manufacturing variances very fundamentally, not so much around mix.

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James Philip Sidoti, Sidoti & Company, LLC - Research Analyst [35]

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Okay. Right. And why don't you think that, that will continue?

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Clarence R. Verhoef, Varex Imaging Corporation - Senior VP & CFO [36]

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History is a little bit of our guide here, unfortunately. So I mean you've seen that we have times where particularly with an aging factory in Santa Clara, we've had some ups and downs with that one. And so those are things that are challenges to us. And I would say also as we -- and we talked about this last quarter is, as we ramp up new products, particularly around CT tubes, you end up with a learning curve that happens in the factory around those products. And yield gets a bit of a challenge until we get all the formulas figured out and get the exact details of how to manufacture them effectively and efficiently.

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James Philip Sidoti, Sidoti & Company, LLC - Research Analyst [37]

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Okay. So the last 2 questions for me. In fiscal '19, it seems like the revenue was kind of 48% first half of the year, 52% the second half. Is that something you think will -- I know you don't want to get into too much details on the quarters, but a little bit higher revenue in the second half than the first half of the year. Is that reasonable?

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Clarence R. Verhoef, Varex Imaging Corporation - Senior VP & CFO [38]

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Yes, Jim, I think it's actually a good story for us that we did have a more evenly balanced year. Because if you go back and look at FY '17 and '18, we had quarters that had a fair amount of variability to them. And so as we looked at -- as we went through FY '19, we saw a little more evenly balanced revenues by quarter for sure. And some of that is as our portfolio broadens, as we have more and more products out there and more customers as such, it helps to do a little bit of smoothing of that. I think that's probably the biggest factor that's going on right now. And so just using FY '19 as our guide, I would say FY '20 would be something similar. Keeping my fingers crossed as such because that's not always perfectly predictable.

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James Philip Sidoti, Sidoti & Company, LLC - Research Analyst [39]

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Right. All right. And then the last question from me. If we get out of bed tomorrow and the trade war with China is resolved, the tariffs go away. You've done a lot to kind of mitigate the impact of the tariffs. What would be the impact on you guys if all of a sudden they went away?

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Sunny S. Sanyal, Varex Imaging Corporation - CEO, President & Director [40]

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Yes. So overnight, there will be some nominal impact of the additional duties that we're paying on some imports, but the real impact for us will be slightly longer term, because you recall, what we did was in response to the tariffs, we expanded our production footprint into China and Germany. And secondly, we went up -- we started to develop out our supply chain in China. And that takes a little bit of time to materialize. So essentially, we had planned to do that as part of the China 2025. So we would have done these things somewhere in 2023. But instead, we put those pieces in place now. So what we will -- what you should see is then within 12 months or so that we would see a nice benefit from lower cost materials from China that if we don't have to pay that 25% tariffs. So yes, that would be a gross margin impact, I'd say, 12 months after something in events like that.

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Operator [41]

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The next question comes from Larry Solow with CJS Securities.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [42]

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A couple of follow-ups. Just on the tax rate and effective tax rate in the quarter. And did that include -- and what was this -- you had a $1.5 million sort of nonoperational tax adjustment? What exactly is that?

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Clarence R. Verhoef, Varex Imaging Corporation - Senior VP & CFO [43]

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So the -- there are losses in certain jurisdictions that are not tax deductible. But one of those jurisdictions happens to be, the losses are associated with the Direct Conversion, the non-GAAP adjustments of Direct Conversion. And so that's the adjustment associated with that.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [44]

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Okay. So you added that back. So the effective tax rate in the quarter was that 21% including that, or it was less than those that before that adjustment?

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Clarence R. Verhoef, Varex Imaging Corporation - Senior VP & CFO [45]

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That was including that. And 21% is for the year. I think the effective tax rate was lower than that for the quarter.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [46]

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Okay. That's what I thought I was trying to figure that out. Okay. Do you happen to have that number handy?

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Clarence R. Verhoef, Varex Imaging Corporation - Senior VP & CFO [47]

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I'm going to go a little bit off the top of my head on this one. I think it's somewhere in the range of about 13%, somewhere in that kind of range.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [48]

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Okay. So you had a benefit in the quarter that helped you out...

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Clarence R. Verhoef, Varex Imaging Corporation - Senior VP & CFO [49]

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Exactly. I think the other thing tax reform that happened with U.S. tax reform a year ago has made some of this stuff pretty complicated. And so one of the challenges that we had was determining how to handle the profits that are outside the U.S. And so there's new regulations about that, some special regulations. And we got -- after we did a lot of hard work on that, we ended up with a reasonably good adjustment because I expect the tax rate to be a bit higher than what we ended up at. We were 21%, and I was expecting to be a couple of points higher than that for the year. And so I do think we got a little bit of a nice benefit from that perspective.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [50]

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Right. Because I think last quarter, if I'm not mistaken, you had -- actually part of your guidance adjustment, you had mentioned that the tax rate was going to be higher for this year. And I thought that was going to be maybe maintained into next year. But I guess the question is, so it's down again back to the lower 20s. Is that any to do with China? Because I know if you turn profitable there, that would actually eat your overall tax rate.

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Clarence R. Verhoef, Varex Imaging Corporation - Senior VP & CFO [51]

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Yes, we still have a bit of a challenge in China, and that's why part of why the rate -- my projection on the rate for next year is still a little bit higher than what it was in FY '19 because we do have some exposure there in China if we have -- still continue to have losses there.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [52]

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Okay. And just on the X-ray CT tubes in China. I know last year, you put out a forecast, and you met that forecast of volume more than doubling. Any directionally -- I know you didn't give one today, and I'm not necessarily expecting you to keep continuously giving us a scorecard on that, but directionally, is that continuing to grow this year? Is it maybe timing related, perhaps not growing as -- or modest growth? And I know some of these agreements and these dollar amounts that were thrown out, like the $140 million number that was mentioned. Those would -- just remind us, those are really just purchase agreements, right? They're not obligated to purchase that amount, all right? So -- and don't some of those already expired, I think they're already coming up on the 3-year anniversaries, right?

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Sunny S. Sanyal, Varex Imaging Corporation - CEO, President & Director [53]

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Yes, Larry, so this is Sunny. So our agreements with our customers tend to roll over into -- they -- we keep renewing them. And so as these agreements would come up for their term period, we just sit down and renew them again. So that still be -- they'll sort of be evergreen in that sense. The trajectory of the CT business is still an upward trend, and we expect it to continue to be an upward trend for 2 reasons. One, the CT market growth in China is still expected to be strong. And secondly, we expect now that to start seeing better uplift from the replacement tubes for the initial tubes that were sold over the last 12 to 18 months. So we're bullish about the China CT market. But for -- again, we gave onetime color to give you a feel for the trajectory. We're going to stop keeping that score going forward. And because it -- so the answer to your question is we're expecting a continued positive trajectory.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [54]

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Understood. Understood. But just to help us calculate it because I know, myself included, we sort of took that number at first glance, whatever it was, $125 million and then try to prorate it over a certain time period, but in theory, it's -- that's not really correct, right? Because that time period is shifting -- I mean, clearly it shifted, right?

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Sunny S. Sanyal, Varex Imaging Corporation - CEO, President & Director [55]

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Overall, if you take the -- some customers brought their products on time, some are delayed. All-in, if I were to blend this all out, there was about probably a 1 year, I'd say, blended. I'm just making an educated guess here. Roughly a 12-month slide across a group of about 8 or 10 customers. So of the trajectories, I mean, I'd say, the curve is the same. It hasn't...

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Lawrence Scott Solow, CJS Securities, Inc. - MD [56]

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Okay. So in theory, you could still get that, whatever that may be $120 million over a 3-year period, it's not necessarily a 5-plus-year period, maybe it's 4 or ish, I'm not giving -- you don't want to give exact. Okay. That's helpful.

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Sunny S. Sanyal, Varex Imaging Corporation - CEO, President & Director [57]

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As we had said, the NPI cycles are -- had a regulatory risk embedded in them. I'd say that we're just seeing -- what we're seeing is just natural course of NPI introduction and time lines.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [58]

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And just last question on the tariffs. Did the exclusion -- Section 301 exclusion, I assume that would help you in the short run at least, because you'll still have some supply chain costs -- higher supply chain costs, it sounds like until you fully develop your -- developed by your supply chain. Is that -- so would that be a little bit of a benefit for you? Or is it not such a big deal.

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Clarence R. Verhoef, Varex Imaging Corporation - Senior VP & CFO [59]

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Yes, it makes tariffs, at least for the near term, a nonevent for us for stuff that's being imported into the U.S. So that was not a large number to us in FY '19. So I think -- so it's helpful for us, but it's not a major, major factor.

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Operator [60]

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We have reached the end of our question-and-answer session. I will turn the call over to Mr. Goldman for closing remarks.

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Howard A. Goldman, Varex Imaging Corporation - Director of Investor & Public Relations [61]

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Thank you for your questions and participating in our earnings conference call for the fourth quarter and fiscal year 2019. A replay of this quarterly conference call will be available through November 26 and can be accessed at the company's website or by calling 1 (877) 660 6853 from anywhere in the U.S. or 1 (201) 612 7415 from non-U. S. locations. The replay conference call access code is 13695628. Goodbye.

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Operator [62]

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Thank you. This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.