Varex Imaging Corp

NASDAQ:VREX

Earnings Call Transcript 2023-Q1

[Operator]

Greetings and welcome to the Varex First Quarter Fiscal Year 2023 Earnings Call. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host Christopher Belfiore, Director of Investor Relations. Thank you, Christopher. You may begin.

[Christopher Belfiore, Director of Investor Relations]

Good afternoon and welcome to Varex Imaging Corporation's earnings conference call for the first quarter of fiscal year 2023. With me today are Sunny Sanyal, our President and CEO; and Sam Maheshwari, our CFO.

Please note that the live webcast of this conference call includes a supplemental slide presentation that can be accessed at Varex’s website at vareximaging.com/news. The webcast and supplemental slide presentations will be archived on Varex’s website.

To simplify our discussion, unless otherwise stated, all references to the quarter are for the first quarter of fiscal year 2023. In addition, unless otherwise stated, quarterly comparisons are made sequentially from the first quarter of fiscal year 2023 to the fourth quarter of fiscal year 2022. Finally, all references to the year are to the fiscal year and not calendar year, unless otherwise stated.

Please be advised that during this call, we will be making forward-looking statements, which are predictions or projections about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties that could cause actual results to differ materially from those anticipated. Risks relating to our business are described in our quarterly earnings release and our filings with the SEC.

Additional information concerning factors that could cause actual results to materially differ from those anticipated is contained in our SEC filings, including 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.

On today’s call, we will discuss certain non-GAAP financial measures. These non-GAAP measures are not presented in accordance with, nor are they a suitable for GAAP financial measures. We provide a reconciliation of each non-GAAP financial measure to the most directly comparable GAAP financial measure in our earnings press release, which is posted on our website.

I will now turn the call over to Sunny.

[Sunny Sanyal, President and Chief Executive Officer]

Thank you, Chris, and good afternoon, everyone. We are pleased to report sales of $206 million for the first quarter consistent with our expectations. This was a result of a more balanced operating environment, driven by good demand, and improved supply chain and our internal supply chain initiatives. That said, while demand levels were as expected, product mix was less favorable in the quarter and as a result gross margin was lower than what we had originally anticipated.

With that, let's discuss our results for the quarter. Revenue in the first quarter was down 11% sequentially, but up 3% year-over-year. Revenue in the Medical segment declined 12% sequentially, while the Industrial segment revenue declined 9%. Non-GAAP gross margin in the first quarter was 32%, which was below our expectation, due to a shift in our product sales mix to mid and lower tier products during the quarter. Sam will talk more to this during his prepared remarks.

Adjusted EBITDA in the first quarter was $25 million and non-GAAP EPS was $0.21. We ended the quarter with $108 million of cash, cash equivalents and marketable securities on the balance sheet, down $5 million from $113 million in the prior quarter, this was primarily due to higher inventory in the quarter.

Now let me give you some high-level insights into the market environment based on an assessment of demand that we are seeing for different modalities and applications. Medical segment revenues increased 3% year-over-year and decreased 12% sequentially. Across our product portfolio, we believe our customers are exhibiting cautiousness as they asses an uncertain economic environment ahead.

Many of them are still facing challenges fulfilling their backlog, primarily due to material shortages. As a result, demand globally for CT tubes were soft, while demand in other medical modalities including fluoroscopy, oncology and mammography was flat to down. Demand for dental and radiographic products were stable to up.

Revenues in our Industrial segment increased 5% year-over-year and declined 9% sequentially. Demand for industrial tubes and detectors remained strong in the quarter, led by strength across non-destructive inspection products. Security markets continued to slowly improve as our customers converted their prior period tender wins into orders for us at a higher rate.

Throughout Varex’s history, we are focused on investment in R&D and innovation in the field of X-ray imaging. We see the X-ray based imaging industry continuing to evolve and as long-term component supplier to imaging OEMs, we are at the center of this evolution. This is very evident as we met with our customers at RSNA this year.

As you may know, each November, we attend the Annual Radiological Society of North America Conference in Chicago. This is the largest radiology trade show of the year and is well attended by both our OEM customers and our peers. With over 31,000 participants in attendance, this conference provides us a significant opportunity to take the pulse of the markets we participate in. This year, RSNA was a very meaningful event for Varex as our customers returned to the show with a pre-COVID level presence and enthusiasm.

Specifically, we saw a significant shift from conversation centered around supply chain woes to active conversations around new product development and our role as a component supplier to them for these future products. Photon counting technology stood out as a key highlight of our discussions at the conference with many customers interested in our technology and how it could be integrated into their new products. The focus was mainly on performance, resolution, image quality of photon counting technology, as well as dose reduction and spectral imaging capabilities. We believe there is a significant opportunity with our photon counting technology for both medical and industrial applications and we continue to make progress with our CT customers for potential integration into their systems.

With regard to some of our other detector products, customers continue to show a high level of interest in our dynamic detector platform called Azure. A number of our customers are already using this platform across various modalities and we expect continued integration given the level of interest we saw. Our radiographic customers remain excited about our LUMEN detectors, which continue to gain interest. LUMEN is a highly competitive radiographic detector platform currently targeted at the approximately $400 million segment of radiographic market where we have low market share. We are excited about the LUMEN family of detectors and are working on a number of projects in 2023.

While AI software has been part of our RSNA in the past, it felt more palpable this year with a very large exhibit footprint dedicated to this technology. A key area of interest was AI software related to lung screening. As we have highlighted in the past, we believe our AI aided lung cancer screening software Veolity will benefit from a global focus on proactive lung screening.

Last year, we installed six Veolity platforms in various locations in British Columbia. All of these systems are working well and have provided runway to be involved with a tender process in Manitoba. In Ontario, we have a test installation that could also lead to a tender process. The conversations with current and prospective customers support our view for the continued evolution of the X-ray industry towards new technologies.

While some of these products are several years from being commercialized, there is no doubt that the industry is evolving into a higher technology arena in line with where we have dedicated R&D dollars. With over 70-years of expertise in the imaging industry and strong customer relationships, we are a critical player in making this evolution a reality.

Turning back to the quarter, while demand in the first quarter was per our expectation, as we start the second quarter, we're seeing a softer demand environment. We expect this change in market dynamic to lead to revenues that will be flat to slightly up for the year. Further, we expect the less favorable product mix we experienced in the first quarter to continue into the second quarter.

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

[Sam Maheshwari, Chief Financial Officer]

Thanks, Sunny, and hello everyone. As a reminder, unless otherwise indicated, I'll provide sequential comparison of our results for the first quarter of fiscal 2023 with those of our fourth quarter of fiscal 2022.

In the first quarter, demand and supply came in balance. As a result, we are reporting sales of $206 million at the midpoint of our guidance. Non-GAAP gross margin was 32% below our expectations, primarily due to lower margin product mix. Non-GAAP EPS was $0.21.

First quarter revenues were down 11%, compared to the seasonally high fourth quarter of fiscal '22. Medical revenues were $160 million and industrial revenues were $46 million. Medical revenues were 78% and industrial revenues were 22% of our total revenues for the quarter.

Looking at revenue by region, Americas decreased 7% sequentially, while EMEA decreased 13% and APAC decreased 14%. This was against a seasonally strong fourth quarter. Sales to China were 17% of our overall revenue for the quarter.

Let me now cover our results on a GAAP basis. First quarter gross margin was 31%, 100 basis points lower than the prior quarter. Operating expenses were $50 million flat, compared to the fourth quarter of fiscal ‘22 and operating income was $13 million, down $12 million. Net earnings were $3 million and GAAP EPS was $0.08 based on fully diluted 41 million shares.

Moving on to the non-GAAP results for the quarter. Gross margin of 32% was down 100 basis points sequentially driven primarily by low margin product mix. While demand in the quarter was in line with our expectations of a product mix in the medical segment changed. We saw reduced sales of higher margin, higher-end CT tube and certain detector products. In the Industrial segment, we saw lower service revenue, which typically carries a higher margin profile. This product mix shift caused approximately 100 basis points of margin compression in the quarter, compared to the fourth quarter.

We believe some customers are taking a more cautious stance either due to the macroeconomic environment or challenges fulfilling their backlog, due to supply chain shortages. R&D spending in the first quarter was $20 million flat, compared to the prior quarter. It was 10% of revenues at the high-end of our targeted 8% to 10% range, due to seasonally low sales level in Q1.

SG&A was approximately $27 million flat compared to the prior quarter as a result as G&A was 13% of revenue. Operating expenses were $47 million or 23% of revenue, which was flat sequentially. Operating income was $18 million, down $11 million sequentially, due primarily to the lower gross margin. Operating margin was 9% of revenue, compared to 13% in the fourth quarter of fiscal 2022.

Tax expense in the first quarter was $2 million or 15% of pretax income, compared to $4 million or 17% in the fourth quarter of fiscal 2022. We are now modeling 25% tax rate for full fiscal year 2023, due to certain tax reform related favorable items, as well as increasing R&D and foreign tax credits. Net earnings were $8 million or $0.21 per diluted share, down $0.22 sequentially. Average diluted shares for the quarter on a non-GAAP basis were $41 million.

Now turning on to the balance sheet. Accounts receivable decreased by $15 million from the prior quarter, due to lower sales in the quarter, compared to the prior quarter and DSO increased two days to 70 days. Inventory increased $17 million in the first quarter. As a result of this, days of inventory increased to 203 days. While it is common for our inventory to increase in our first fiscal quarter, we expect inventory to decrease going forward. Accounts payable increased by $8 million and days payable was 55 days.

Now moving to debt and cash flow information. Net cash flow from operations was a use of $4 million in the first quarter, due to an increase in inventory, employee incentive payments and the biannual coupon payment on our debt. We ended the quarter with cash, cash equivalents and marketable securities of $108 million, a decrease of $5 million from the fourth quarter of fiscal 2022.

Gross debt outstanding at the end of the quarter was $450 million and debt net of $108 million of cash and marketable securities was $342 million. Adjusted EBITDA for the quarter was $25 million and adjusted EBITDA margin was 12% of sales. Our net debt leverage ratio was 2.5 times at quarter end.

Now moving on to guidance for the second quarter. As we talked about earlier, we are providing outlook for revenue in fiscal 2023 to be flat to slightly up, compared to the prior year. Separately, we believe hospitals are seeing good patient and elective procedure volume. However, higher in capital expenditures and long-term payback projects are being reevaluated. This phenomenon is cascading over to us as a somewhat unfavorable product mix.

As a result for the second quarter of fiscal year 2023, revenues are expected between $205 million and $225 million and non-GAAP earnings per diluted shares are expected between $0.05 and $0.25. Non-GAAP earnings guidance includes an anticipated $2 million payment for technology transfer milestones in R&D. This would equate to approximately $0.04 in non-GAAP EPS.

Our expectations are based on non-GAAP gross margin in a range of 31% to 32%, non-GAAP operating expenses in a range of $48 million to $49 million, temporarily high due to the anticipated R&D milestone payments. Tax rate of about 25% for the second quarter and the rest of fiscal year 2023 and non-GAAP diluted share count of about 41 million shares.

With that, we will now open the call for your questions.

[Operator]

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question is from Young Li with Jefferies. Please proceed with your question.

[Young Li, Jefferies]

All right, great. Hey, everyone. Thanks for taking our questions. Can you hear me alright?

[Sunny Sanyal, President and Chief Executive Officer]

Yes, we can hear you alright, Young.

[Young Li, Jefferies]

All right, perfect. I guess maybe just to start on the cautiousness from customers' comments. I was wondering if you can expand upon that a little bit more, which products, end markets, geographies are more impacted? And what's holding up better? I mean, it sounds like some of your customers are maybe seeing some more deferrals or cancellations as well?

[Sunny Sanyal, President and Chief Executive Officer]

Hey, this is Sunny. The cautiousness comes from just the general conversations that we've had with customers and the actual softening in order intake rates of the call offs as we call them that we're seeing from them. And without exception, every conversation that we've had with our customers, they've indicated to us that they're sitting on a backlog of whip that they can't get out of the door, because they're missing some component in their systems that they're building. These are not in our tubes or detectors; these are other parts and components that they're missing.

So -- and that's causing them to rebalance some of their inventory and enhance the orders to us. Now that's what's driven us to look at our forecast for the rest of the year and we've indicated that we're seeing some softening.

[Young Li, Jefferies]

All right, great. Very helpful. I guess maybe one more on I guess, the China market is attractive and important. I guess, what are you seeing and hearing on the ground related to the COVID disruptions during the quarter? And how has that changed, if any, in January? And how long do you think that market might take to sort of normalize?

[Sunny Sanyal, President and Chief Executive Officer]

Li, what we're seeing in China, first of all, with COVID, there was disruption across the board for most of our customers. They're trouble getting people to work and get product out of the door. So there is somewhat of a similar situation as I described earlier with -- unable to get product out of the door, but in their case, it was a lot of it was also tied to labor. We motor through it, we managed to deliver all the things that were needed.

In terms of CT and our strength in China is heavily -- we've been very heavy on CT and doing well with CT. There's been a lot of CT buying and although the Chinese government continues to reinforce their investment in healthcare. This year, we expect that there'll be some softening in demand and going down from the traditional just [kinetic] (ph) buying to more traditional growth rates. So again, early signs, early indicators, there's no sign of slowing down of overall investments in healthcare and CT buying we expect will continue.

And for us, it's a two-pronged, right? One is new sockets that we get through a lot of these activity. By the way, there's been continued activity with R&D and new design wins as the Chinese OEMs continue to bring out new models. So one -- first prong is new sockets and the second prong is we've now sold quite a bit of new sockets into China. We expect their replacement revenue stream from that to continue and should help us in the future.

[Young Li, Jefferies]

All right, great. Appreciate the color. I'll get back in queue.

[Sunny Sanyal, President and Chief Executive Officer]

Thanks, Young.

[Operator]

Thank you. Our next question is from Larry Solow with CJS Securities. Please proceed with your question.

[Larry Solow, CJS Securities]

Great. Thanks and good afternoon or good evening. Just a follow-up just on the demand or the questions on the somewhat lower at least from a high level of the revenue outlook. So it seems like it's a combination of things. I guess, it's some -- just supply chain issues that are continuing and you mentioned just things caught up in the whip. But I guess also the hospital spending over capital expenditure sort of reassessment. That seems to be somewhat of a newer phenomenon, I guess. And how does that flow to the OEM like, are there orders? It sounds like the OEM orders are still good, so I'm just trying to figure out does this hospital slowdown? Is that like a next step? So, does that maybe make this slow down a little bit longer? Just trying to kind of connect the dots there.

[Sam Maheshwari, Chief Financial Officer]

So, hi, Larry. This is Sam. Yes, so what we are hearing from hospitals and the CEOs, what they're saying is that although they are seeing very good patient volume and elective procedure volume. And as you know from prior history, we have -- we are connected to the hospital CapEx somewhat particularly to the elective procedure volume overall. And what they are saying is that they are under tremendous profit pressure, so to say, in the sense their expenses are running quite high. And so in order to maintain their profits, they are looking at everything. And this is what we've heard more from the United States based hospitals.

And as they look at it, they're scrutinizing their capital expenditures and also everywhere that they can manage their expenses better. And in this scenario, what we are hearing is that longer term ROI type of projects which are much higher in terms of capital layout. Those are probably being deferred or delayed. And anything that can increase patient volume, et cetera, is already being taken care of. So we believe that is causing a little bit of push out on the higher end products or higher end machines and that is cascading over to us. That's what we believe it's happening over there. Of course, we are one step removed, but that's what we mean.

[Larry Solow, CJS Securities]

Right. Okay. So it sounds like it’s obviously end market demand is all based on -- well patient volumes to sure drive your long-term business? But I guess you can never -- customer behavior can shift around and maybe they can decide to hold less CT machines or whatever in the long run. But I guess that's very hard to decide for -- in a couple of quarters.

And then just on China, so just trying to get a little better read on that. I feel like -- I put China in the govern, they're still behind this initiative in terms of the CT machine build out. And then I thought that was sort of accelerating in 2020 to have all these freestanding centers that are just CT centers or imaging centers including CT. So how would that slow? Like, to me, two years, it doesn't seem like catch up that fast as to where they'd be slowing down noticeably up to you guys at least. So I'm just trying to get a little more, yes color on that.

[Sunny Sanyal, President and Chief Executive Officer]

Yes, if you look at our growth in China, that's been at very high clip 20%, 30%-ish type of growth in terms of the buying. So this month is holiday month in China. There's New Year, so hard to call it a trend. But in general, we're not seeing a slowing of government investment. We're not seeing a slowing in expansion of healthcare. So the question becomes and is it going to continue -- how long is it going to continue at 305 pace? That's the part that I think as we look ahead, we can see a couple of quarters. We can't see beyond that, but we're just putting it in that same bucket of the softening to same. If the trends are probably global trends, so -- but CT continues to be strong and right behind CT in China is cardiovascular and oncology. Those are the newer modalities that are starting to pop up. So overall, prospects of China for us continue to remain strong.

[Larry Solow, CJS Securities]

Okay. That's fair. So I mean, just a growing -- growth rate. I mean, you can't grow 30%, 40% forever, I get that. So, but selling is still growing there. And then just clarify the COVID related shutdowns in Q4 or calendar Q4? I know we did then talk from some other manufacturers and stuff that, that normally that quarter is more of accelerated manufacturing and overtime and whatnot because then they know there's sort of a slowdown in Chinese New Year. So it's kind of a double whammy. But I feel like you guys haven't been impacted that much by the COVID shutdown. There is always the CT build out over the last couple of years during -- even the heart of COVID. So was that -- did that have any play on your results for this quarter or this quarter's outlook?

[Sunny Sanyal, President and Chief Executive Officer]

Go ahead, Sam.

[Sam Maheshwari, Chief Financial Officer]

Yes. So Larry, the medical products were exempted all through that process. And so yes, there was somewhat of a disruption, but not major. We continue to produce all through the last many quarters. And so it was neither a big -- it was not something that impacted us very much. And so we are not expecting that, that opening up would increase significantly for us either, because it really did not impact us significantly that way. And as I said, our products were exempted and so we've been continuing to produce through and ship them.

[Sunny Sanyal, President and Chief Executive Officer]

And our operations during this time were stable and so with our customers.

[Larry Solow, CJS Securities]

Yes. Right. Okay, if I could just squeeze one more, just to revenue slower, maybe little -- it sounds like inflation still hurt you guys in labor costs aren't fair, but hopefully those are going in the right direction. I'm just trying to set; are there any leverage you can pull? Or you guys done a good job last couple of years sort of keeping costs down and where you can in a tough environment. So if revenues outlook is a little slower, can you -- is there any offsets maybe over the next few quarters you could or you sort of just not much you could do on that side?

[Sam Maheshwari, Chief Financial Officer]

Yes, so I think there are certain levers, but there is always a timeline associated with those levers, Larry. So what's happening is that the price cost drag on the P&L, cost increase happens sooner than price improvements get realized on the P&L, that's the price cost drag. That's kind of hurting us about 200 basis points right now. And in the December quarter, freight was high. Freight is beginning to improve as we speak since January. So that was a drag of about 100 basis points on our gross margin. So hopefully in couple of months, freight begins to improve.

And we talked about mix, and I'm hoping mix is a shorter-term phenomenon and maybe it impacts us in the first half and gets to improve from the second half onwards. We -- mix is very difficult to predict or difficult to control, but that is how I'm thinking. Mix is impacting about 100 basis points. So overall in terms of us improving our gross margins and us improving our financials, we are laser focused on improving manufacturing efficiencies and that supply chain pressure get eased a little bit and they are, they have been improving steadily now for a few months. So as that gets eased, our manufacturing efficiency should come back into play.

And so the volume, we are still expecting flat to slightly up as we said in our prepared remarks. So it is still a positive for us, but maybe not as much as we thought about it three or four months ago, but we -- the offsets would be manufacturing efficiencies hopefully mix comes back. And I'm thinking as a few quarters go by, the price cause drag that gets more in shape.

And then finally, in our inventory, we have some high-priced semiconductor chips in our inventory that will roll through. So my thinking is by the end of calendar year, the price cost drag and the high margin -- high-cost chips have rolled through the inventory and that's how I'm looking at it.

[Larry Solow, CJS Securities]

Okay. And I appreciate that color. That's great. Thanks again, guys.

[Sunny Sanyal, President and Chief Executive Officer]

Thank you.

[Operator]

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

[Suraj Kalia, Oppenheimer]

Sunny, Sam, can you hear me alright?

[Sunny Sanyal, President and Chief Executive Officer]

Yes, we can, Suraj. How are you?

[Suraj Kalia, Oppenheimer]

Hope you guys are well. So Sunny, Sam, obviously you guys made a lot of commentary about forward-looking outlook. Sunny, maybe specifically, I want to compare and contrast, if I could. So if you look at the commentary from GE Healthcare, right, they presented quite a bullish outlook in terms of cash spend, imaging and sound across the spectrum. And if I remember correctly, there wasn't that level of caution. You guys have a relatively sort of forward-looking contracts, a significant portion of your revenues are recurring help us reconcile?

On one hand, there is caution and from you guys, but on the other hand, some of the bigger players are -- its guns blazing. What are we missing in this picture?

[Sunny Sanyal, President and Chief Executive Officer]

I'll get started and I'll ask Sam to add more color. Our OEMs their schedule and of where they are with their orders and order -- their cycles of order to delivery versus ours are slightly different, right? So the OEMs had a strong bookings quarter, let's say, last couple of quarters. And if they're sitting on inventory right now of stuff that they haven't shipped yet, haven't been able to ship yet, that includes our components. So our current quarter is -- might be -- is softer and slower because their output is slower, it has already has our stuff in it. Then as that moves -- as that whip moves through the system, then we would expect certain amount of order input, progress, call offs for us than in the future quarters.

So as we sit in Q2, we're expecting that softness, because I think our OEMs are sitting in that position of working through their whips. And so as then -- as that whip clears, as time goes by, I think then we end up progressing through the year. So with that in mind, we're looking at our run rates of revenues and that's why as we did all the math, we're saying this is likely to be more like flattish to up versus growth, because it starts to then bunch up towards the second half. And then as we look at recessionary environment and what we're hearing from -- also from customers is that they're having trouble scheduling delivery of some of the larger modality products. The smaller products are going in between, sort of, the capital budgeting process and are making their way into the hands of the customers.

But anything that requires facility modification is getting scheduled out further out, because of CapEx squeeze and other variety of different competing priorities at our -- their customers. So with all that and we try to paint a picture for ourselves of what does we only get visibility so much visibility, two quarters worth. But this is as we look further out, we're trying to paint this picture and hence our cautionary note.

[Sam Maheshwari, Chief Financial Officer]

I think Suraj, I would also like to add here is that my understanding or belief is that hospitals are carrying six to nine to 12 -- not hospitals, sorry, our customers are carrying six to nine to 12 months of backlog, whereas we are carrying four to six months of backlog. So the backlog is the buffer that enables our customers to kind of ship through to their customers. Whereas us with less than two quarters of backlog, we see it a bit sooner. That would be one way to also think about the difference between us and our customers.

[Suraj Kalia, Oppenheimer]

Got it. And Sam specifically for you, I'll hop back into queue after this. You made some comments in terms of the gross margins. Obviously, they came a little softer than our expectations. Maybe I missed it, Sam. Was there any shift in customer credit terms, DSOs, any additional line-item color would be greatly appreciated. Gentlemen, thank you for taking my questions.

[Sam Maheshwari, Chief Financial Officer]

Thanks, Suraj. Yes, now there wasn't really any change in terms of customer credit or DSO. DSO, increased by one or two days, so largely remained flat. I think at this point the credit or customer credit or that type of an issue is not at play here. As I mentioned that the gross margin did come below our expectations, as well and that was mostly around the mix. And mix can change for us and it is also very difficult to get a visibility on for us. So it was really mix that caused the gross margin to come in a bit lower than our expectation.

And I'm hoping and we are guiding Q2 with that same somewhat unfavorable mix at this point. But we are thinking mix -- if our thinking is right, we believe mix should come back -- should improve back again after Q2, that's what our current thinking is.

[Operator]

Thank you. Our next question is from Anthony Petrone with Mizuho Group. Please proceed with your question.

[Sunny Sanyal, President and Chief Executive Officer]

Anthony, we can't hear you.

[Anthony Petrone, Mizuho Group]

Oh, apologies. Line was muted. Good afternoon, Sunny and Sam. Maybe just staying on the theme here, the outlook. And to really splice it a little bit finer geographically. It sounds like it is broad-based? In other words, that you're seeing similar sort of trends, whether it be in Europe and the U.S. specifically and maybe a little bit better as it relates to trends in China, although they're currently going through COVID in the current quarter. So maybe just to fine tune it a little geographically, are the headwinds that you're hearing from customers more acute in the U.S.? Are they more acute in Europe? How are they faring in China? And then I have a follow-up.

[Sunny Sanyal, President and Chief Executive Officer]

Sure. Anthony, it feels fairly broad-based, I would say. The variability right now we see is more in by modality. So modalities like dental, we did -- we saw strength in dental, the fluoroscopy and oncology in these other mid-tier model. The non-CT modalities, they're flat to down. And these are pretty heavy modalities that high price points and require a lot of work. And by the way, for those, our customers are in all regions of the world. And then CT felt, CT was soft, and not as much by geography. I don't know if that helps to -- answer your questions more by modality.

And China is -- their strength this is probably just a cyclical thing or just a consumption issue and COVID all that tied into some level of softness we're not expecting anything dramatically different there.

[Anthony Petrone, Mizuho Group]

And then maybe more near-term in the first half, some of the chip companies and AMD and Intel called out just some lingering headwinds in 1Q, but that toward the back half of the year, the outlook for chips improves a bit. I mean, should we expect some of the pressure as you relate to your full-year guidance to be more front end loaded instead of back end loaded?

[Sunny Sanyal, President and Chief Executive Officer]

Yes, just one quick comment. We tend to be about 90, 120 days ahead of everyone else ahead of OEMs, right? Because of where we sit in the supply chain process. So if the OEMs end up clearing up their whip backlog that they're currently stuck on, then things will start to open up for us in the second half. But again, that's a bit unknown, because you can only see six months or so.

[Sam Maheshwari, Chief Financial Officer]

Yes. And then, Anthony, I can add if your question was also referring to cost side or the Intel, AMD pricing perspective and then how it goes to us on the cost side. We are also -- we -- when we are procuring chips, not just FPGAs, all kinds of chips, we go out many years. So -- and many years, I mean, 12 to 24 months and in some cases even beyond 24 months. So of course, as the chip situation improves then what we would be procuring in second half, that would be favorable.

But right now, what we have in inventory already is at high cost and that is what I think I mentioned in an answer to Young question before is that, that high-cost chips are in inventory now and they are rolling through. And based on our projections, most of that would have rolled through by -- towards by the end of this calendar year. So that's our situation. But whatever Intel, AMD, et cetera, are saying that would definitely help us in the future periods.

[Anthony Petrone, Mizuho Group]

Thank you very much. I'll get back in queue. Thank you.

[Sam Maheshwari, Chief Financial Officer]

Thanks, Anthony.

[Operator]

[Operator Instructions] Our next question is from Jim Sidoti with Sidoti & Company. Please proceed with your question.

[Jim Sidoti, Sidoti & Company]

Hi, good afternoon. Thanks for taking the questions. First one on inventory, the increase in inventory, I guess two questions, why now? And now that you have inventories at this level, are you confident that you won't have any stock out issues for the remainder of the year? Do you have all the key components you need for fiscal 2023?

[Sunny Sanyal, President and Chief Executive Officer]

Yes, Jim. Hi, Jim. Yes. So there are a couple of reasons for growth in inventory and inventory has increased for at least for a few quarters now. So as we began Q1, we were planning for a higher growth rate and so we were positioning our inventory accordingly. Going forward, we will adjust it somewhat to adjust the new forecast or new projections that we are planning. But I do want to remind you, because Q1 is a seasonally low revenue quarter for us, and that's more on demand supply side and right now demand and supply are largely in balance. So the Q1 results were mostly a reflection of the demand levels.

But from an inventory management perspective, we have to go on an even keel. So if you look at many -- if you look at our prior Q1s and inventory performance there. Generally, inventory in the last four, five years has grown by about $20 million. So in Q1, inventory grows by $20 million on where it ended in Q4. It's because generally we grow in Q2, Q3 and Q4 is generally the high quarter for us.

So growth of $17 million is not unusual for us from an inventory growth perspective. But I do accept that inventory was a bit high already. And so -- and because as I said, we were driving towards a little bit higher revenue and so we're now going to adjust it. And it should come down partially, because of our adjustment actions, but then also as revenue growth and the midpoint of our guidance is higher than Q1 actual revenue. So all of those things should help to bring down inventory going forward. So that's the situation on inventory. I hope, I answered your question, Jim.

[Jim Sidoti, Sidoti & Company]

Okay. Yes, yes. And then we -- following up on that, so I would assume and you'll see positive cash flow from operations for the remainder of the year. As you start to work down that inventory?

[Sunny Sanyal, President and Chief Executive Officer]

Jim, generally, we do not guide cash flow from operations or cash balances. But provided, we are successful in bringing inventory down. That should provide -- that should be a good factor to bake in for the cash performance of the company for the remaining quarters. In general, you're thinking right, but I could not say that -- I could not guide you to that, but in general, inventory should provide a positive response to cash as opposed to be a downward pressure on cash.

[Jim Sidoti, Sidoti & Company]

Okay. And then is there any update on the joint venture with Micro-X and the expansion into Southeast Asia and India?

[Sunny Sanyal, President and Chief Executive Officer]

Yes. So Jim, on the Micro-X question, that is we -- the Micro-X announcements that we had done. We have five milestones for through R&D to pay them for the technology transfer. It is in a way than acquisition financed through the P&L. In a way, you could look at it that way. So we are expecting one milestone was completed and we are expecting two more milestones to be completed in Q2. That is why our operating expense guidance in Q2 is a bit higher. And then after that two more milestones would be left; I do not have a specific view at this time when the remaining two milestones would be completed. So that's that on -- on that collaboration.

And then your second question about Southeast Asia, that really South Asia and I believe you're referring to our initiatives in India. Is that right?

[Jim Sidoti, Sidoti & Company]

Right.

[Sunny Sanyal, President and Chief Executive Officer]

Yes. So in India, we're making progress. We've made incremental progress at this time; we've made certain payments to the government for acquiring the land. We are just in the final phases of completing that purchase. Hopefully, we have made the payments and now we are trying to work towards getting the position and those type of agreements done. And so progress is full speed on that initiative. And look forward to having good things come out of that initiative in 12 to 18 months, more like 18 months, I would say.

[Jim Sidoti, Sidoti & Company]

Okay. And then the last one for me, can you just repeat comments you made regarding interest expense and share count for the second quarter?

[Sunny Sanyal, President and Chief Executive Officer]

Yes. In terms of share count, given our EPS guidance range used for -- due to ASU 2026 or yes, because of that, our share count for EPS calculation purposes, toggles between 41 million shares or 49 million shares. So for the Q2 guidance range for EPS, we are using 41 million shares. And then what's the second question, Jim?

[Jim Sidoti, Sidoti & Company]

The interest expense.

[Sunny Sanyal, President and Chief Executive Officer]

Interest expense, I would just model, I did not provide any guidance on interest expense, but they should at least at this point. No change from Q1 really, whatever debt we are carrying, $200 million on convertible that is at 4% and about $243 million on high yield note. That's about 7.875 interest rate. So that should continue. I just want to remind you, maybe you heard our comments, I just want to remind you that coupon on both the debts is payable in the same quarter. So we pay coupon interest payments in Q1 and Q3. And so maybe that is what you're asking. So we're not expecting a cash coupon payment in Q2, but of course, we would recognize the expense over Q2 for that.

[Jim Sidoti, Sidoti & Company]

Got it. All right. Thank you.

[Operator]

Thank you. Our next question is from Michael [Indiscernible] with Mizuho Securities. Please proceed with your question.

[Unidentified Participant]

Hey, guys. How are you doing? Just looking at -- you guys are carrying a fair amount of cash or have been? And then I saw some comments at the recent equity conference that you were at. How are you viewing the capital structure? I know you've caught the bonds a couple of times; I think you have one claw available left. Are you just going to stockpile cash until you, sort of, debt closer to that convert maturity? Or how are you guys thinking about the cap structure and your use of cash in regards to that?

[Sunny Sanyal, President and Chief Executive Officer]

Yes. Thanks Mike. So what we have said that we want to keep $100 million of cash as operating cash and we reported about $108 million of total cash at the end of December quarter. So we do not have that much more cash that we are carrying at this time, compared to the cash levels that I would like to carry for. Just general operations. I want to remind you that our cash is distributed across various geographies. We are a multinational company and movement of cash, et cetera, sometimes may have bad tax consequences. And so as a result, cash is not at one place.

So that said, your comment in terms of one tranche that is possible for us to pay that is true. Every calendar year, we can pay down 10% of our high yield notes. So that is at this point about $243 million, so that gives us an opportunity to pay down about $24 million in debt as and when we have sufficient cash to pay that down and provided our Board of Directors approves that. So pending those two things, we can do that. We have highlighted that retiring that is a high priority for us.

And that said, as we look towards our business, typically, we generate cash. So as our cash from operations improves our cash balance. We would like to, overall, bring down the overall debt levels. Right now, the debt levels are about $450 million on the company. And we would like to bring it down by about $100 million. When is the right time for that? Depends on various factors, but that is what something we would like to get to. At the right time, when the environment is right, and when we can execute towards that.

[Unidentified Participant]

Okay, great. And then so you did mention that your coupons are both coincidentally in the same quarters Q1 and Q3. So Q2, Q4 should be sort of a cash influx, right, relative to sort of what we saw this quarter, right, because the coupon doesn't get paid. So your high watermarks on cash generally going to be Q2 and Q4, does that sound right?

[Sunny Sanyal, President and Chief Executive Officer]

In general, from a modeling perspective, that is right. But from tactical, prospective AR, AP, and then et cetera. And it pertains to that, but in general, your thinking is right. But we would like to make sure we have sufficient windage over that in terms of tactical movements. But in general, your thought is on the right direction, Mike.

[Unidentified Participant]

Okay, great. Well thank you very much for taking my question.

[Sunny Sanyal, President and Chief Executive Officer]

Thank you, Mike. Take care.

[Operator]

Thank you. There are no further questions at this time. I'd like to turn the floor back over to Christopher Belfiore for any closing comments.

[Christopher Belfiore, Director of Investor Relations]

Great. Thank you. Sunny, do you have any final comments?

[Sunny Sanyal, President and Chief Executive Officer]

Yes. Thank you, Chris. So in closing, I mean, the quarter was largely as expected and outside of the gross margin pressure from the -- from revenue mix. Economic uncertainty is creating caution across various industries. But as we continue to view the healthcare industry, we participate in as a stable -- we see the healthcare industry as a stable grower over the long-term. I'm very proud of the effort our employees are making globally on a daily basis in this uncertain environment. And I appreciate you're taking the time for us to join -- for joining us today and for your continued interest in Varex. Thank you.

[Christopher Belfiore, Director of Investor Relations]

Thanks, Sunny. And thank you all for your questions and participating in our earnings conference call today. The webcast and supplemental slide presentation will be archived on our website. A replay of this quarterly conference will be available through February 14 and can be accessed at our website vareximaging.com/investors or by calling 877-660-6853 from anywhere in the U.S. or 201-612-7415 from non-U.S. locations. The replay conference call access code is 13735486. Thank you and goodbye.

[Operator]

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