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Varex Imaging Corporation  (NASDAQ:VREX)
Q1 2019 Earnings Conference Call
Feb. 05, 2019, 5:00 p.m. ET

Contents:

Prepared Remarks:

Operator

Greetings, and welcome to Varex Imaging Corporation First Quarter Fiscal Year 2019 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Howard Goldman, Director of Investor Relations. Please go ahead, sir.

Howard Goldman -- Director of Investor & Public Relations

Good afternoon, and welcome to Varex Imaging Corporation's earnings conference call for the first quarter of 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 the quarter are fiscal quarters. Quarterly comparisons are for the first quarter of fiscal 2019 versus the first quarter of fiscal 2018 unless stated otherwise.

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.

Guidance for 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 guidance 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 is contained in our SEC filings, including Item 1A risk factors of our annual report on Form 10-K for fiscal year 2018. 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.

Sunny Sanyal -- President & Chief Executive Officer

Thank you, Howard. Good afternoon, everyone, and welcome to the start of our third year as a public company. Last week we celebrated our two-year anniversary, and we look forward to many more years of continued innovation, strong customer relationships and growth.

We had solid performance in the first quarter of fiscal year 2019. Revenues increased 5% or more than $9 million from the prior year quarter. Medical segment revenues increased 3% and Industrial segment revenues grew 13%. We had a nice improvement in our gross margin rate from the second half of last year, in particular the direct impact from tariffs in the first quarter was lower than we expected. Clarence will have more specifics in a few more minutes.

As you may recall, last year, U.S. tariffs increased by 25% on purchases that we make from suppliers in China for certain components used in our products, like printed circuit boards. In addition, on the products we export from the U.S. to China, tariffs increased by 25% on digital detectors and by 5% on X-ray tubes. To help mitigate these increases in tariffs, we previously outlined plans to accelerate the expansion of manufacturing operations in China and Germany.

We have made good progress to date and expect production of some product models to start during the second half of this year. Having a number of manufacturing sites around the world gives us the flexibility to be closer to our customers and realign production with local commercial leads.

In our Medical segment, we continue to see strong demand for our CT, oncology and mammography imaging products. During the first quarter, shipments of CT tubes to our OEM customers in China continued to gain momentum and we are on track to ship more than twice as many units as we shipped last year. Some customers are nearing the end stages of development while others are in the regulatory approval process for their new CT systems. We anticipate adding new pricing agreements with some of the smaller OEMs over the coming quarters.

In addition to the opportunity for our CT tubes in China, we see our customers continue to expand their global presence into emerging markets with products in the value segment of the CT market. One of our largest OEM customers has recently introduced a CT scanner for emerging markets. We're optimistic about their potential success and other growth opportunities for our products in the value segment of the CT market.

Demand for digital detectors also remains solid, but the story is a bit mixed. Sales of our upper-tier dynamic detectors improved from the prior year, while lower-tier radiographic detectors declined due to the impact of tariffs and competitive factors. We continued to see growth in sales of digital detectors and X-ray tubes for radiation therapy systems.

The radiation oncology space is projected to grow at the rate of 5% over the next five years, driven by increasing incidences of cancer, growing elderly population and technological advances. Both radiation therapy systems and corporate X-ray imaging products are used for treatment planning and patient positioning. We expect oncology to continue to be a strong contributor to our growth for fiscal year 2019 and beyond.

Sales of products for the mammography market grew the first quarter. We have a broad offering of imaging components and software for mammography, and continue to see a strong demand for components, particularly for X-ray tubes.

In our Industrial segment, revenue growth was driven by strong demand for our linear accelerators for non-destructive imaging applications and cargo screening at ports and borders. And industrial X-ray tubes used for security screening CTs at airports. We expect demand for security tubes -- tubes in Industrial remain high in the upcoming quarters as airports around the world continue to invest in baggage screening systems using CTs.

Our non-destructive testing business is off to a good start this year. We completed integration of the VMI acquisition that we closed last year. Most of its focus is in the refinery segment of the oil and gas market, where VMI's proprietary imaging software is used to inspect valves and pipelines. We are encouraged to see several new potential opportunities to combine our digital detectors with VMI's proprietary software for pipeline and refinery inspections.

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

Clarence Verhoef -- Chief Financial Officer

Thanks, Sunny, and hello, everyone. I would summarize Q1 as a quarter with good top line performance particularly in the Industrial segment and better than expected gross margins which were partially offset by higher SG&A expense.

Tariffs, once again, had an impact on our business, but a bit different than we initially expected. Originally, we had expected our OEM customers would ask for price concessions to help offset tariffs that they would pay for the import of digital detectors. Instead, we saw a decline in radiographic detector sales in China during the quarter.

Above these lowered revenues, our gross margin rates actually improve due to fewer sales of these lower margin products. Roughly offsetting this gross margin rate gain was a reduction of about 70 basis points due to direct payments of supply chain related tariffs in the U.S. and China.

Our first quarter revenues were up 5% compared to the quarter a year ago which had experienced a slowdown in sales of digital detectors for the 3D dental and oncology markets.

Medical segment revenues for the first quarter increased 3%, despite the reduction of radiographic detector sales. Industrial segment revenues were up 13% driven by increased demand for CT tubes for airport security and higher linear accelerator shipments for both security and non-destructive testing applications.

Looking ahead, we expect to have some additional variability in quarterly revenues due to various geopolitical issues such as Brexit, U.S. government shutdowns and tariffs. For example, we have seen some delays in receiving export licenses for our linear accelerators, which could change the timing of future shipments. For the first quarter, our gross margin was 32% compared to 35% in the prior year.

During the quarter, we completed the closure of the Santa Clara detector fab operations and recorded $4 million of accelerated depreciation as a restructuring charge. The adjusted gross margin was 36%, which was comparable to the year ago period. Sequentially, gross margin rate improved by about 3 points from Q4 of FY 2018 due to lower manufacturing variances in Santa Clara less impact from tariffs and a favorable change in product mix.

R&D expenses were $19 million or 10% of revenues in the quarter compared to $20 million or 11% in the year ago quarter. First quarter SG&A expenses were $31 million compared to $28 million in the prior year. In the first quarter, we had approximately $1 million of restructuring cost associated with headcount reductions. In addition, we had higher than usual professional accounting fees and incurred additional legal expenses, primarily associated with a patent litigation matter that we had initiated.

Depreciation and amortization totaled $14 million for the first quarter compared to $9 million a year earlier. The current quarter included $4 million of accelerated depreciation associated with the restructuring of the detector fab operations.

Our operating earnings for the first quarter were $10 million, down from $14 million in the same quarter a year ago. Our operating margin rate was 6% in the first quarter, a decline from 8% in the year-ago quarter, reflecting the restructuring cost. For the first quarter, our adjusted operating earnings were $20 million compared to $18 million in the prior year. The adjusted operating earnings margin was 11% compared to 10% in the prior year.

Interest expense in the first quarter was $5 million, which was slightly lower than the year-ago quarter. We had other expense of approximately $1 million in the first quarter and the prior year quarter, primarily due to the results from investments in privately held companies.

Our effective tax rate before discrete items for the first quarter was 23% compared to 25% in the prior year. As a reminder, last year we recorded significant one-time tax adjustment due to U.S. tax reforms.

Net earnings for the quarter were $3 million or $0.08 per diluted share compared to $11 million or $0.30 per diluted share in the prior year quarter. Adjusted net earnings for the quarter were $10 million or $0.26 per diluted share compared to $9 million or $0.23 per diluted share in the prior year quarter. Diluted shares outstanding were 38.3 million shares versus 38.2 million shares in the prior year.

Looking at our working capital, accounts receivable decreased by $21 million during the quarter. Days sales outstanding was 65 days compared to 66 days in the prior year. Inventory increased $22 million in the first quarter to $257 million. The increase was primarily due to the transition of supply with the closure of the Santa Clara fab operations and projected demand for the second half of the year.

We ended the first quarter with cash and cash equivalents of $55 million. For the quarter, we had cash flow from operations of approximately $20 million and spent $3 million for property, plant and equipment while reducing debt by $15 million. Our net debt position or total debt less cash was $320 million at the end of the quarter.

We are not changing our outlook for fiscal year 2019. As a reminder, the guidance we previously provided was revenues in a range of $755 million to $780 million, including $10 million to $15 million of anticipated impact from currently enacted tariffs. And the adjusted net earnings per diluted share between $1.25 and $1.55.

Now, we will open up the call for your questions.

Questions and Answers:

Operator

At this time, we will be conducting a question-and-answer session. (Operator Instructions) Our first question comes from the line of Anthony Petrone with Jefferies. Please proceed with your question.

Anthony Petrone -- Jefferies -- Analyst

Hi. Good afternoon. Thanks for taking the questions here. I'm going to maybe start on the gross margin side, and then move into a few just order-related questions both in Medical and Industrial. On gross margin, if you look at the trend, it's sort of 4Q to 1Q sequentially. In prior years, it should have been down to the tune of 200 plus basis point higher than that in the prior year. You were up 310 basis points sequentially, and so you walked through some of the drivers there. But Clarence and/or Sunny, can you kind of recap how much was mix related, how much was Santa Clara related, and how much of this is sort of sustainable going forward? And then I will have a few follow-ups. Thanks.

Clarence Verhoef -- Chief Financial Officer

I think, Anthony, it's an interesting one to compare with the Q4 in particular, because I do think that Q4 of FY '18 was a little bit on the light side no doubt, I mean, in terms of the high amount of impact that we had from Santa Clara fab operations. And so getting a little bit of that behind us and having that gain from not having as much manufacturing variances in that fab in Q1 is certainly a big factor. The second highest is going to be around the mix in terms of the mix of what we're selling. And it's not insignificant when you have less of those lower margin radiographic detectors coming into play, so that's a significant factor as well. Tariffs, I think, it's comparable with Q4, so I don't think that is as much the swing as more the prior two items.

Anthony Petrone -- Jefferies -- Analyst

Okay. So, is it safe to say that this level that we're seeing here is sort of good proxy for how gross margin trends for the full year?

Clarence Verhoef -- Chief Financial Officer

Well, I mean, mix is always a bit of challenge for us, right, in terms of predicting what that mix is going to be. But I think it certainly is heading in the right direction from that perspective. And then at the same time, I do think we have a little bit of an upside that happens with the full exit from Santa Clara fab, because we don't have the full impact of that yet hitting us, because we still had it running in terms of the cost structure that we had there, and that goes away a fair amount starting in Q2.

There is a little bit of time for us to use up the inventory that we had built. As I mentioned, that we built up some inventory there. That's at the prior valuations and cost structure, and so it will take us a little bit of time to use that up. So I'm feeling like it's second half of the year kind of time frame when we start to see the favorable impact of the closing of that fab.

Anthony Petrone -- Jefferies -- Analyst

That's helpful. And then one on China OEM. Is there a way to -- just you sort of mentioned some orders here. What amount of orders sort of in dollars from China OEM did you have in the queue? And then what is reasonable for the year? You said you expect it to sort of double this year, but is there a way to sort of frame that in dollars?

And then just on Industrial, can you just kind of give us a sense of what VMI contributed in the quarter, the acquisition that was announced last quarter? And how much that contributed to growth in industrials? Thanks.

Clarence Verhoef -- Chief Financial Officer

I'll start with the last one first just because it's a quick and easy one, which is overall the VMI business is somewhere in the order of magnitude of $5 million to $7 million kind of business, somewhere in that kind of range. So you just do that by a quarters worth and it's not a large number in terms of driving the growth. I mean it helps certainly, but it's not a major factor.

I'm not going to go into specific details of orders in China in terms of -- because first of all we don't really talk about orders unless we've had some very large significant one that we put into the backlog as the pricing agreements that we have. But I would say that two things, I guess. One is, I touched on that, we had a decline in sales of radiographic detectors there, but at the same time we had nice performance on CT tubes and that puts us on track for what we had said before of the number of units shipping there doubling.

Anthony Petrone -- Jefferies -- Analyst

Okay. Thanks. I will get back in queue. Thanks.

Sunny Sanyal -- President & Chief Executive Officer

Okay.

Operator

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

Larry Solow -- CJS Securities -- Analyst

Great. Thanks, guys. You guys don't guide to the quarter per se, but could you just give us a little -- just a bit of flavor? Normally Q1 is I believe seasonally the slowest quarter of the year for you. But if I look back last year, I know your Q1 was exceptionally slow especially in the Medical side where a lot of orders on the flat panel detectors that were pushed out.

So, in relation to that and sort of mid-single digit growth in the quarter on the Medicals up overall, and I think, 3% on a Medical. How should we view sort of the rest of the years because -- rest of the quarters because your guidance sort of implies at least on a year-over-year basis some feel to take -- look at the midpoint some still lower to mid-single digit declines for the rest of the year?

Clarence Verhoef -- Chief Financial Officer

So Larry, I mean, I guess, it starts with just kind of stand and you touched on a little bit which is that we had a soft Medical quarter a year ago, our net sales in the Medical segment year ago. And now it's driven by two segments in particular, the dental space and the oncology space more lighter than usual. I would say that those followed up in the second quarter last year were pretty strong quarters. So, I mean, I think, from that perspective, we actually have a bit of a tough comp going into Q2 for the medical space.

And then, I mean, overall, you've got the things going on with China and CT is certainly still going to be a big driver of growth for us as we look for the balance of the year and that's in the Medical space. So, I mean, I think, that's certainly one of the things that's got a nice uptick. And then I would say that the business or the amount of business that we see in the oncology and the mammography space is good indicators of kind of the level of demand that we have there. So, I'm not sure I fully answered your question, but I think it kind of covers a little bit about the balance of the year for Medical.

Larry Solow -- CJS Securities -- Analyst

Okay. And then just on -- you gave some good color on the gross margin and then gross profit outlook. Obviously, when -- I think the Santa Clara facility, I know has been a pretty big drag for you guys. So elsewhere if that closes, it sounds like you already got some improvement in this quarter even though the facility was still open, but hopefully going forward then it will, it would be -- but you see even more which is fine.

Just how about the SG&A side a little bit. I know that's been sort of (inaudible) side just on the increased level there and didn't seem like it was reduced too much this quarter. So with an absolute basis or as a percentage of revenue, is that -- something is still focused on and perhaps an opportunity to materially improve your margin?

Clarence Verhoef -- Chief Financial Officer

Yes, I mean, I'm -- SG&A had a couple of unusuals this quarter. The first being the -- we went through a sizable amount of work to close out last year with the audit in the first time implementation of socks and there's a fair amount of fees associated with that. So that was an uptick in expense that was just in Q1.

The other one that was the -- we had some litigation expense associated with patent that we are defending. We are defending our own patents, and that increased some expense as well. So as our -- now that's not a done deal right, so there's still some additional expense to be had on the litigation side for sure.

At the same time, we end up with a higher than usual SG&A as a percentage of revenue. But as I look forward to the year we are targeted to be around 13%. I still see us having a good shot at getting to that. And it's more about managing the cost structure as well as get a little bit of revenue growth in there, the math helps you a little bit there.

Larry Solow -- CJS Securities -- Analyst

Okay. And just a question on China, just a quick follow-up, you mentioned it sounds like certainly in the contracts you already have customers are advancing and you sort of reaffirmed that expected doubling or more than doubling in unit sales. Just on the follow-up to that, you mentioned you have some smaller OEM customers in the queue that you expect some orders from. Are there -- I would assume it's a pretty big market opportunity and I believe you have like five of the 10 OEMs on the contract already of some sort. Are there larger -- maybe not in the near future, but larger contract opportunities as we look out maybe not in the next one to two quarters, but over the next one to two years that you hope to buy for or how is that outlook? Has anything changed on tariffs or spending patterns or anything in China?

Sunny Sanyal -- President & Chief Executive Officer

Hey Larry, this is sunny. Let me take that. Of the 10 OEMs, it's safe to say, we're playing with everyone. The first five that we signed purchase agreements with, they were the largest ones. And what's remaining after that are sort of down the line smaller OEMs. So if you look at the next 12 months to 18 months, I would say we will end up getting many of those, but they won't be anywhere materially of the size of what we've already closed. It will be much smaller.

Larry Solow -- CJS Securities -- Analyst

Yeah, fair enough. Go ahead, I'm sorry.

Clarence Verhoef -- Chief Financial Officer

Well, Larry, one other comment I guess is that from a U.S. and also about tariff impact, and there is -- what we've seen with the CT tubes, first of all, it's a much smaller tariff rate that's been added on those and we've not seen any impact on the business there from that perspective. No change in our customer's plans.

Larry Solow -- CJS Securities -- Analyst

Right. So it sounds like that $10 million to $15 million, I know you're not changing that in your guidance, but at least through Q1 that the overall impact from tariffs is at least trending toward at least the lower portion of that number, if not below it. I know it's only early in the year but is that fair to say?

Clarence Verhoef -- Chief Financial Officer

Yes. I guess there's couple of factors there. One is that you got to always remember there's different parts to tariffs. One is what we pay and it's in our cost structure whether we're importing stuff from China or whether we are the importer of record when we ship something into China. And then the impact on the top line, I still, think it's in that range the 10% to 15 %. It's a little -- fair amount of volatility with it just because some of it might be still price concession, some of it might be just business that went away. We had kind of similar impact, when currency moved three, four years ago, we had similar kinds of things where it was we had to do price adjustments and the like and so we still have some of that potential as well.

Sunny Sanyal -- President & Chief Executive Officer

And Larry, second part of your question about is have we seen any changes in the environment in China.

Larry Solow -- CJS Securities -- Analyst

Yes.

Sunny Sanyal -- President & Chief Executive Officer

We haven't and actually it's been the recent announcement by the Chinese purchasing authorities that they're going to buy 3,000, 3,500 CT systems by the end of 2020. That's only reinforced -- continuously reinforced, it's an additional data point proving out the market opportunity, and we're not seeing any -- none of our customers are escalating in their investments.

Larry Solow -- CJS Securities -- Analyst

Excellent. That's great. I know that the tariffs on the tubes are relative or there is already a small minuscule amount and now that's just increased by a little bit, right. So, it's mostly over the (inaudible) impact.

Sunny Sanyal -- President & Chief Executive Officer

It was 5% more than what is fit for.

Larry Solow -- CJS Securities -- Analyst

Okay, great. And just last housekeeping question, to book the other expense of $1.2 million what was that? Is that below the line?

Clarence Verhoef -- Chief Financial Officer

So that's been in our --

Larry Solow -- CJS Securities -- Analyst

JV?

Clarence Verhoef -- Chief Financial Officer

Yes, the JV, that's the detector manufacturer there dpiX so.

Larry Solow -- CJS Securities -- Analyst

Got it. (multiple speakers) So that was a bit of a positive for --

Clarence Verhoef -- Chief Financial Officer

Yeah. And we do have a little bit of variability in that business that's just going to go up and down at time just on kind of how their operations are running.

Larry Solow -- CJS Securities -- Analyst

Okay. But as overall directionally that should be a positive contributor I would say, right? Or, I mean...

Clarence Verhoef -- Chief Financial Officer

We run at the -- no, its, you know be at a low -- it's a low profit level kind of business, and so most of the positive impact that we get with that is all about the cost structure for what we buy from them. So if they -- as they reduce cost which they are doing that and they are making good progress in reducing cost that reduces our cost of goods, it doesn't necessarily hid in that other R&D line.

Larry Solow -- CJS Securities -- Analyst

Got it. Okay. Thanks. Appreciate that.

Clarence Verhoef -- Chief Financial Officer

Sure.

Operator

Our next question comes from the line of John Koller with Oppenheimer. Please proceed with your question.

John Koller -- Oppenheimer -- Analyst

Good afternoon, gentlemen. How are you?

Sunny Sanyal -- President & Chief Executive Officer

Good. How are you?

Clarence Verhoef -- Chief Financial Officer

Good. Hi, John.

John Koller -- Oppenheimer -- Analyst

Good. It's Oppenheimer & Co just for a fair advertising. Couple of quick questions. I went through the a tandem on the adjustment. And I just wanted to make sure I didn't see the legal expense and the professional expenses were not part of the adjustment to get to the adjusted EPS. Did I read that correct?

Clarence Verhoef -- Chief Financial Officer

Yes, that's right. I did not -- I did not treat those as adjusted items, they are part of our ongoing regular business I guess. They are not onetime.

John Koller -- Oppenheimer -- Analyst

Okay, great. Just wanted to make sure. I don't suppose you want to give any information on the patent litigation? Just leave that out there and we'll see it in the Q?

Clarence Verhoef -- Chief Financial Officer

There'll be a little bit of color in the Q as well, but nothing more to add at this point in time.

John Koller -- Oppenheimer -- Analyst

Okay, great. Really quickly then on the manufacturing expansions in China and Germany. I'm going to guess that you are probably some time away from achieving solid efficiency on those. Wondering if you have a timeline and if you think that they're acceptable or if it's just too small at this point?

Clarence Verhoef -- Chief Financial Officer

It's small at this point. The way we're going to roll that out is we'll dribble it out in the product line at a time. So there's really not going to be a material impact in productivity one way or another.

John Koller -- Oppenheimer -- Analyst

Okay. And I guess those are going to be fairly, maybe in Germany, you can see a little more upmarket, but in China, you are probably going to keep those at the mid to lower technological advancement at this point?

Sunny Sanyal -- President & Chief Executive Officer

Yes. So, we have existing facilities in Germany, where it came through our PerkinElmer acquisition. So there's a mix of products. The PerkinElmer products were largely what's made in Germany. And in China it would be again a mix of products both PerkinElmer -- the legacy PerkinElmer and Varex products that we sell into China. So it's a mix of products, blend of products.

John Koller -- Oppenheimer -- Analyst

Okay, great. Then if I could ask on the further margin improvement and ability to cut costs. I assume with one quarter and still you're still pretty confident that you'll be able to achieve the previously announced targets for cost reductions?

Clarence Verhoef -- Chief Financial Officer

Yes, I don't think anything is changed from that perspective. I mean, and I look at things like, OK, R&D, we're running around the 10% level which is what we had said we wanted to be at. So -- and I think with the SG&A, it's about the unusual items or maybe the items that hit us in Q1 are not getting forward so much after that. And then gross margin, we always got a lot of factors going on. I mean, we talked on those a little bit relative to the product mix as well as some of our cost reduction actions that are going on. But I don't think that changes anything in terms of outlook.

John Koller -- Oppenheimer -- Analyst

Okay. And then my last question is really on Industrial. There was sizable improvement in the quarter, and I know you've mentioned that you'll see some shifting going forward based on the ability to get linear accelerators out the door. But I'm just curious if you can have -- if you're seeing any traction on the efforts and the assets you've deployed in Industrial, beyond what you've seen so far that gives you some confidence, may be not this year but may be in the out years that you're taking appropriate action to really go out and get that market. Thanks.

Sunny Sanyal -- President & Chief Executive Officer

I will just take it and maybe Clarence you can fill in. Hey John, we -- second half of last year, we announced a realignment to focus on Industrial and that is having an impact, and we're seeing that in the growth in our Industrial X-ray tubes business which not the linear accelerators which are the higher energy the normal energy kV energy X-ray tubes that is we've seen pretty good traction there and we expect that will continue and its investments for the long term.

Beyond that I think we already have a very strong Industrial detector business where we expect some additional growth to come from will be through the acquisition of VMI. The VMI brings us some software, proprietary software in the oil and gas vertical. So we're bullish about being able to expand further into oil and gas vertical with our existing products, our tubes and detectors by packaging them with VMI's offerings because they've got a good channel and a good market presence in the oil and gas segment.

John Koller -- Oppenheimer -- Analyst

Right. And I guess one last one I just want to say, congrats on debt repayment. I know Q1 is generally pretty soft quarter especially after this Q4 that you had last fiscal year, but I'm glad to see the focus on debt reduction. Thanks.

Sunny Sanyal -- President & Chief Executive Officer

Sure. Thank you, John.

Operator

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

James Sidoti -- Sidoti & Company -- Analyst

Good afternoon. Can you hear me?

Clarence Verhoef -- Chief Financial Officer

Yeah, we got to hear and how are you?

Sunny Sanyal -- President & Chief Executive Officer

Yeah.

James Sidoti -- Sidoti & Company -- Analyst

Good. So you've said over and over there is two impacts in tariffs. The tariffs -- the concessions you need to make to your customers as a result of the tariffs they're paying, and then there's also the tariffs you pay on materials you purchase. That second component you indicated that was a little bit less this quarter than you thought. Why was that?

Clarence Verhoef -- Chief Financial Officer

I think that it wasn't significantly less but slightly I think it's more volume related than anything in terms of the amount of products that were either moving across boarders whether it was stuff that we imported and went into our inventory? Or whether it was the number of shipments that we did to China?

James Sidoti -- Sidoti & Company -- Analyst

So essentially the product mix helped you both on a gross margin line and with the tariff access?

Clarence Verhoef -- Chief Financial Officer

Yes, to a certain degree, I think you're right. There is a little bit of another hidden benefit I guess from product mix that is linked back into the tariffs.

James Sidoti -- Sidoti & Company -- Analyst

Do you have any expense if things could go the other way for the rest of the year? Or do you think that this is a trend that will continue?

Clarence Verhoef -- Chief Financial Officer

I actually think that Q1 is a pretty good indicator of what the year is looking like in terms of the mix of tariff impact, but we're very early in the year from that perspective and so it's a little bit difficult to give specifics on the out layer quarters.

Sunny Sanyal -- President & Chief Executive Officer

Okay. Right. Thank you.

Okay. All right. Thank you.

Clarence Verhoef -- Chief Financial Officer

Sure.

Operator

Our next question comes from the line of Anthony Petrone with Jefferies. Please proceed with your question.

Anthony Petrone -- Jefferies -- Analyst

Thanks. Just another one to stay on tariffs. Maybe just I know that there was handful of different variables as it relates to tariffs. One was those related directly to China OEM, your supply materials, but also multinational OEMs potentially having to shift their supply chains around. And so how -- is all of that kind of factored into the $10 million to $15 million? If it's not what areas could potentially surprise either to the upside or downside?

And again, should we get some favorable announcements come March or April whatever the case may be. How quickly can you unwind some of the efforts to offset tariffs? Here again we get a favorable announcement that there's a less of a two way sort of trade war going on between China and the US? Thanks, again.

Clarence Verhoef -- Chief Financial Officer

Well, I'll answer the second part first again which is that if there gets to be resolution and some of these tariffs go away, the obvious one is the part that's hitting us on the cost side. Okay. So we get that benefit, 70 basis points or so that we had of impact in the first quarter that goes away. So we get an uptick there.

And then the more difficult to measure part is that what does that mean on the top line stuff. Certainly, the ones where we've given price concessions, we've structured those in a manner where they are very clearly identifiable and separate line on the invoice, et cetera, so that it's clear that we're doing a price concession because of tariffs. And so that goes away then we get that benefit track. Now the ones where it's a little more indirect or the business has gone away because somebody doesn't want to pay the tariff that's still to be determined about how do we get that business back, I would say that we always have ongoing conversations with these customers, so I think there is a good likelihood that we would get that business back.

Sunny Sanyal -- President & Chief Executive Officer

Hey Anthony, let me just add to that. This is Sunny. The changes -- operational changes that we made to counteract tariffs were part of our original plan always in our business. We just accelerated them because of the tariff. So we have to address China 2025. So eventually our customers, Chinese customers and our multinationals want local sourcing in China. So we're not going to -- maybe I misunderstood your question, we're not going to unwind those actions. We just -- we put those in motion, we accelerate those and the costs associated with that are part of our guidance for the year, where we will see a benefit is exactly what Clarence described. The tariffs go away, then some material parts cost will go away, but our investments in China, the capital investments we made, we will just keep those going toward our long-term goals.

Anthony Petrone -- Jefferies -- Analyst

That's helpful. And last just follow-up from me would be again revisiting VMI, I know, it's small, but how much of a gross margin impact does that have in the queue. And are VMI margins on that $5 million to $7 million, are those above corporate average?

Clarence Verhoef -- Chief Financial Officer

I would say their margins are comparable with our business. There's a little bit -- again they have within their own business, they have a bit of mix thing going on too. How much of it is their soft -- proprietary software that they're selling versus how much is passed through of components versus how much is Varex components being sold. So it can be any of those three. And obviously the more software the better margin, the more Varex components versus pass-through of a third-party product would be also higher marginally. But overall what I see in the numbers is that they are comparable with the rest of our business.

Anthony Petrone -- Jefferies -- Analyst

Okay. Then the last one if I may just a housekeeping one on, again on the debt acceleration pay down, and just how that flows through the earnings? I mean, how should we think about -- how that plays into the reaffirmed adjusted EPS guidance? How much of that is a benefit? And then any update just on the tax guidance as well would be helpful? Thanks.

Clarence Verhoef -- Chief Financial Officer

Yes. I actually don't think anything changes on either of those. I think, at the beginning of the year, we have said that interest expense was going to be in the $18 million to $20 million. The debt reduction is in line with what I would say are cash flow generated which is going toward debt reduction is right in line with what I would expect for the year. So that's -- I don't think anything changes from that perspective. Tax, I said, 23% to 24%, where 23% this quarter. So it feels like it's also still in line.

Anthony Petrone -- Jefferies -- Analyst

Okay. Great. Thanks.

Operator

(Operator Instructions) Our next question comes from the line of Larry Solow with CJS Securities. Please proceed with your question.

Larry Solow -- CJS Securities -- Analyst

Great. Thanks. A quick follow-up. Just on the R&D side, you guys have done a pretty nice jump last year. I know as you sort of took some of the tax benefit and reinvested in the business which is equating and also we'll see some of those benefits probably a couple of years out. But just for the quarter a little bit of a drop, is that something that we think will -- R&D sort of at least toned down a little bit this year or do you sort of expect to remain at last year's levels or near last year's levels for the full year?

Clarence Verhoef -- Chief Financial Officer

No, last year was around a little almost 10.5%, a little bit north of 10. 5%. So in this quarter I think it was right at 10%. And that's what we're targeting for the year, it is to be around 10%. And it's -- several factors come into play. One is the timing of prototype materials and the like. We had a pretty good uptick of proto costs for CT tubes last year. I think some of that is behind us now, so I think that's -- that gets normalized a little bit.

The other is there is a little bit of R&D costs associated with the Santa Clara fab in terms of supporting that operation. And so we take some of that expense out as well. So the combination of those things puts us in that 10% range.

Larry Solow -- CJS Securities -- Analyst

Great. Thanks.

Operator

As there are no further questions left in the queue, I would like to turn the call back over to management for closing remarks.

Howard Goldman -- Director of Investor & Public Relations

Thank you for your questions and participating in our earnings conference call for the first quarter of fiscal year 2019. A replay of this conference call will be available from today through February 19 and can be accessed at the company's website or by calling 877-660-6853 from anywhere in the U.S. or 201-612-7415 from non-U.S. locations. The replay conference call access code is 13686651. Thank you, and goodbye.

Operator

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

Duration: 43 minutes

Call participants:

Howard Goldman -- Director of Investor & Public Relations

Sunny Sanyal -- President & Chief Executive Officer

Clarence Verhoef -- Chief Financial Officer

Anthony Petrone -- Jefferies -- Analyst

Larry Solow -- CJS Securities -- Analyst

John Koller -- Oppenheimer -- Analyst

James Sidoti -- Sidoti & Company -- Analyst

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