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Varex Imaging (NASDAQ:VREX)
Q3 2020 Earnings Call
Aug 12, 2020, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Greetings, and welcome to the 3Q FY '20 Earnings Conference Call. [Operator instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Howard Goldman, director of investor relations.

Thank you. You may begin.

Howard Goldman -- Director of Investor Relations

Good afternoon, and welcome to Varex Imaging Corporation's earnings conference call for the third quarter of fiscal year 2020. With me today are Sunny Sanyal, our president and CEO; Sam Maheshwari, our new CFO; and Clarence Verhoef, our retiring CFO. To simplify our discussion, unless otherwise stated, all references to the quarter are for the third quarter of fiscal year 2020. Unless otherwise stated, comparisons are to the same quarter of the prior year.

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 substitute for, GAAP financial measures. We provided 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. 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 these forward-looking statements in this discussion.

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

Sunny Sanyal -- President and Chief Executive Officer

Thank you, Howard. Good afternoon, everyone, and welcome. Before we begin, it's my pleasure to introduce you to our new CFO, Sam Maheshwari. Sam brings to us more than 20 years of experience in finance with private and public high-tech companies, and this experience will be instrumental in leading Verax into our next stage of growth.

Sam will have some remarks today before we get into the Q&A. Also, here with us is Clarence Verhoef, who's been our CFO up to this point. On behalf of everyone at Varex, I want to thank him for his service during the past 15 years, and particularly for his leadership during the spin-off of Varex and in getting us established as an independent public company. We wish Clarence all the best in his retirement.

The COVID-19 pandemic began to impact our business in the second quarter of this year, and it began as a shift in mix, largely between our Medical and Industrial segments, along with a bubble of demand in certain areas of Medical such as CT tubes and detectors for mobile X-ray. As the pandemic progressed, in the third quarter, we experienced a further slowdown in sales in our Industrial segment, particularly in cargo and airport security. At the same time, we continued to see an increase in sales of CT and radiographic products. These gains were offset by a significant decline in sales of our products used in elective medical procedures such as cardiology, oncology, dental, and mammography.

The net impact in the third quarter was the revenue decline of 13% from a year ago to $171 million. On a segment basis, medical revenues decreased 9%, and industrial decreased 25% from the prior year quarter. During the third quarter, we continued to see strength in CT, and our volume of CT tubes grew, particularly in sales for new systems, each of which represents a potential for recurring revenues in the future. This growth in CTs came both from our global OEM customers as well as from demand in China.

Despite the turbulence in our medical and industrial markets, we have continued to win new business driven by our ongoing innovation, the strength of our decades-long customer relationships, and our efficient globally local manufacturing operations. Our customers have continued to win in the markets that they serve and rely on our innovative technologies to provide patient-critical components for their systems. In fact, one of our veterinary customers recently celebrated the sale of their 4,000th system using our detectors. Our customers in China, who have been making steady progress with the sales of CT systems, are now experiencing market share gains in their local markets, and we look forward to supplying them with a variety of components as their businesses grow.

In response to the COVID-related decline in revenues and gross margins, we examined our product portfolio very closely, and we decided to discontinue a number of low-margin products in the quarter. The combination of inventory charges for the discontinued products, unfavorable product mix, and additional onetime adjustments led to an unusually low gross margin rate for the quarter. Over the past five months, we've also been taking actions to reduce expenses. The results of those actions are reflected in our operating expenses for the third quarter, which declined by more than 10% sequentially from the second quarter of fiscal year 2020 and also from the prior-year quarter.

Some of these cost actions, such as furloughs, pay reductions, and suspension of 401(k) were temporary in nature and largely aimed at managing our cash flow. In addition to these temporary measures, we also took some headcount reduction actions, which, when combined with other actions, will result in an overall workforce reduction of about 10% this calendar year. The combined impact of these actions is expected to result in cost savings of more than $25 million in fiscal year '21. Some of these actions have been completed, while the others will be carried out between now and early part of fiscal year 2021.

These cost actions, rationalization of our product portfolio, and productivity gains from closing the Santa Clara facility will better position Varex for when the X-ray imaging markets recover from the downturn caused by COVID-19. I want to recognize the contributions of employees that were impacted by our workforce reduction. These were valued employees, and we wish them all the best. We have carefully assessed, reprioritized, and redistributed their work so that we can continue to execute our plans and meet our customer obligations.

On that note, let me hand over the call to Clarence to talk about our financial performance in the third quarter in greater detail.

Clarence Verhoef -- Retiring Chief Financial Officer

Thanks, Sunny, and hello, everyone. Third quarter saw an increased effect of the economic downturn due to COVID-19 on our business. From a financial perspective, it has changed our business in three key areas. First of all, our revenues and gross margin profile changed significantly.

Second, it increased pressure on liquidity, so we modified our capital structure to ensure that we have the liquidity needed to weather the downturn for an extended amount of time. Third, the changing business forecast prompted an examination of our assets to ensure they were properly valued. For the third quarter, revenues were $171 million, compared to $197 million in the prior year quarter. Medical revenues for the quarter decreased $14 million to $138 million, and industrial revenues decreased $12 million to $34 million.

For the third quarter, our gross margin was 15% compared to 31% in the prior-year quarter. During the quarter, we incurred onetime costs of $16 million for the write-off of inventory associated with discontinued products and $1 million of restructuring charges. Excluding these unusual items and other non-GAAP adjustments, our adjusted or non-GAAP gross margin was 26%, compared to 34% in the prior-year quarter. Still included in the non-GAAP gross margin were some unusual expenses that are not treated as non-GAAP adjustments, mainly about $6 million or 4, points of margin from additional inventory reserves, higher freight and tariff costs and property revaluation.

The remaining margin decline from the prior-year quarter was primarily due to unfavorable product mix and lower overhead absorption with the reduced shipments. We did see reductions in operating expenses in the third quarter due to actions taken over the past several months. R&D expenses were $19 million in the third quarter, a decrease of $2 million from the prior-year quarter. R&D expense remained at about 11% of revenues for the quarter due to the lower revenue base.

Third-quarter SG&A expenses were $31 million, same as the prior year quarter. Both periods included approximately $2 million of expenses related to acquisition integration, restructuring and other nonoperational costs. During the quarter, we also recorded a $3 million charge for the impairment of some intangibles associated with the acquisition of Direct Conversion. Depreciation and amortization totaled $10 million for the third quarter, compared to $9 million in the prior year.

The third quarter included $1 million of accelerated depreciation related to the closure of the Santa Clara facility. We had an operating loss for the third quarter of $27 million compared to operating income of $5 million in the year-ago quarter. Our non-GAAP operating loss for the third quarter was $1 million compared to operating income of $19 million in the year-ago quarter. Interest expense in the third quarter was $7 million, including $1 million of noncash interest charges associated with the convertible debt issuance compared to $5 million of interest expense in the year-ago quarter.

Other expenses were $6 million for the third quarter and included $3 million for the impairment of an investment in a start-up detector technology, as well as $1 million of expense associated with the valuation of deferred consideration for the acquisition of Direct Conversion. The remaining amount of other expense was due to losses from foreign exchange and unconsolidated joint ventures. We recorded a tax benefit for the third quarter of $12 million compared to tax expense of $1 million in the prior-year quarter. We had a net loss of $28 million or $0.73 per diluted share in the third quarter, compared to a net loss of $1 million or $0.04 per diluted share in the prior-year quarter.

The non-GAAP net loss for the quarter was $8 million or $0.20 per diluted share, compared to non-GAAP net earnings of $9 million or $0.24 per diluted share in the prior-year quarter. Diluted shares outstanding were 39 million shares compared to 38.3 million shares in the prior-year quarter. Turning to the balance sheet. Accounts receivable decreased by $17 million during the quarter.

Collections remained stable with days sales outstanding at 58 days, same as in the prior-year quarter. Inventory remained flat in the third quarter at $283 million. Cash flow from operations was $1 million for the third quarter and is $25 million for the fiscal year-to-date compared to $49 million for the prior year-to-date. We ended the third quarter with cash and cash equivalents of $87 million, which is an increase of $63 million in the quarter.

Correspondingly, total gross debt outstanding increased by $86 million during the quarter to $469 million. The profile of our debt has changed. We now have total bank debt of $269 million, almost entirely on a term loan, plus an undrawn revolving credit facility with $100 million available. In addition, in the third quarter, we issued $200 million of convertible notes that are due in five years.

The net proceeds were used to reduce the bank debt and increase our cash balance. The notes have a 4% interest rate that is paid biannually and are callable after three years. The conversion feature was set at a 25% premium, but we purchased a call spread to effectively raise that to 50%. We have strengthened our liquidity position with a higher cash balance and availability under the revolver, and we'll continue to drive programs to improve our cash flow, such as cost reduction plans, lower working capital and reduced capital equipment purchases.

As I head into retirement, I want to say thanks for all the support I have gotten from everyone on the Varex team. Over the past 15 years, I've been very lucky to build bonds with so many wonderful people in this company, and I really appreciate their friendship as well as their commitment to the Varex vision. Let me focus on a couple. First of all, I've had an incredible finance team that has worked tirelessly to close each quarter and help me dive into the details of the numbers.

Second, thanks to Sunny and the senior leadership for being great partners for the past four years. And then last, but certainly not least, a special thanks to the legal team and Howard for everything that they have done for me and for Varex. I'm excited about the prospects for Varex, and I have a lot of confidence in Sunny and Sam's ability to lead the company through its next phase of growth.With that, let me turn the discussion over to Sam for some comments on the outlook.

Sam Maheshwari -- New Chief Financial Officer

Thanks, Clarence. I'm excited to join Varex to help lead the company through its next phase of growth and profitability. As a first order of the job, I'll be working on improving the capital structure as well as the operating and cost structure of the company. In the near term, as Clarence noted, liquidity has become a key focus area for us.

Based on our current forecast, we may not be able to meet some of the financial covenants under our existing credit agreement over the next 12 months. Hence, we are actively working on replacing the current credit facility with new sources of debt financing. More information on this will be included in our notice of late filing of third-quarter 10-Q. On the operating side, we continue to take steps to lower costs.

First, the transfer of detector production from the Santa Clara facility to Salt Lake City and other sites will be completed by the end of this fiscal year. The net annual benefit from this consolidation is projected to be approximately $15 million. We expect this benefit to start showing on the P&L starting in fiscal 2021 and be fully reflected in the second quarter of fiscal 2021. Secondly, a few weeks ago, we announced a reduction in force of 94 people.

This reduction is expected to result in annual savings of approximately $13 million and will be fully reflected on the P&L from the first quarter of fiscal 2021. And we continue to partner with our suppliers on cost-reduction opportunities. All these actions lead to a lower cost structure that will position Varex to have better profitability when the economy recovers from COVID-19. Due to the uncertainty associated with the COVID-19 pandemic, last quarter, we withdrew guidance of revenue and EPS for the full fiscal year 2020.

While we reevaluate guidance that can be provided on an ongoing basis, for Q4 of fiscal 2020, we expect revenues to be in the range of $155 million to $170 million. With that, I would like to hand the call back to Sunny for some closing remarks.

Sunny Sanyal -- President and Chief Executive Officer

Thank you, Sam. While there are a number of uncertainties facing us, I am confident that, once the effect of COVID-19 pandemic passes, the markets that we serve and the demand for our products will bounce back. We're an innovation leader with market-leading products and exceptional relationships with our customers. Our end markets are resilient, and there's a life-long need for healthcare and security products.

During this economic downturn, we've remained focused on our long-term strategy and stayed on track with our new product introduction programs. In addition, our facilities are operationally prepared to meet the demand that we expect to see when elected procedures volumes at healthcare facilities around the world and corresponding sales of imaging capital equipment return to normal. Despite the headwinds due to COVID-19, we are confident that not only the fundamentals of our business remain strong, but that our strategies for growth and market leadership are still spot-on. As we have discussed previously, the three pillars of our long-term growth strategy are: First, to drive growth and market expansion via new product introductions and technology innovation to enable new applications.

Second, to drive growth in emerging markets by implementing our local-for-local strategy. And third, to drive growth via expansion into new and greenfield verticals of industrial imaging. We've made very good progress on all three fronts this year, and the momentum continued in the third quarter. Let me tell you a little bit more about progress made each of these areas.

Our customer and market successes is enabled by innovation. It is what we are known for and the No.1 reason why our customers seek us out. Last fiscal year, we launched nearly four dozen new or updated X-ray imaging products across our solution lines. Continuing with that momentum this year, we've begun shipping early versions of our Z Platform detectors to our medical and dental customers.

This platform approaches CMOS-like performance cost effectively. Over time, we expect our Z Platform to be a disruptive technology, which can potentially displace amorphous silicon as a platform in dynamic detectors. We're very happy with the enthusiastic early response by OEMs in surgery, cardiovascular, and dental markets. Along with Z Platform is an array of our next-generation lightweight robust radiographic detectors with market-leading wireless performance that are ideal for both fixed and mobile applications.

We are shipping these detectors in volume now. And in the future, we intend to make these detectors available on rugged non-glass substrate. Our innovation in CT technology has continued in both the high-end segments of CT as well as in the high-volume 16-, 32- and 64-slice segments, intended for emerging markets and value segments of mature markets. Since our recent launch, a full array of collimators for radiographic and fluoroscopic applications, we have shipped over 5,000 units and are beginning to expand our customer base.

We have also continued to make progress with some anchor customers on incorporating our nanotube multi-emitter sources and photon-counting detectors into potential new applications for the future. The second leg of our strategy is to establish ourselves as a globally local company with our local-for-local approach to operations and customer relationships. We are now actively shipping detectors made in Wuxi, and we have been shipping tubes assembled in Wuxi for a while now. As I mentioned before, our local-for-local strategy is targeting both growing relationships with our local OEMs, like we have in China, as well as with our global OEM customers, who want local content, local commercial and operational support from a partner like us.

As you may be aware, we've also implemented our local-for-local program in the U.S. and Europe, to serve our global OEM customers that have manufacturing facilities in these regions. We are unique in this capability, and it is a significant differentiator. The third pillar of our strategy is to drive growth into industrial verticals.

In Q3, we saw a slowdown in sales for airport and cargo security and in oil and gas, but our market development and product development efforts in these verticals continue to move forward. The value proposition for imaging applications is very strong in many industrial verticals, and our perspective on this segment, as a long-term growth opportunity for us has not changed. We are at an important juncture in our evolution as we transition from Varex 1.0 to Varex 2.0. The first version is where, among other things, we stood up a new public company, following our spin off, completed the integration and consolidation of a major acquisition, and expanded our global footprint.

Varex 2.0 will be about driving growth and improving our financial performance and capital structure. Over the coming quarters, we will provide more information on our vision for Varex 2.0. With that, we will now open up the call for your questions

Questions & Answers:


Operator

[Operator instructions] Our first question comes from the line of Larry Solow with CJS Securities. You may proceed with your question.

Larry Solow -- CJS Securities -- Analyst

Great. Thank you very much. And just -- first of all, just Clarence, best of luck to you, and in the same breath, Sam, welcome you.

Clarence Verhoef -- Retiring Chief Financial Officer

Thanks, Larry.

Sam Maheshwari -- New Chief Financial Officer

Thank you.

Larry Solow -- CJS Securities -- Analyst

Absolutely. Yes, my pleasure. Just a couple on the revenue trends. And I realize you guys are a little bit longer cycle.

But it does seem like OEMS at least are spending some money in some cases. So, I'm just trying to decipher some of the mix drop, obviously, in some of your higher-margin markets are more related to elective surgeries. And those things do seem to be coming back, you know, somewhat. And again, I realize you guys are not directly correlated with day-to-day activity, but just trying to figure – you know, any color on our OEMs starting to spend more now? You mentioned there's not much visibility.

You sort of gave some revenue guidance to that. So, I'm just trying to get a little more color on that, if you can.

Sunny Sanyal -- President and Chief Executive Officer

Yes. So, Larry, this is Sunny. Let me give the color on modality front and by geography. First of all, just as a reminder, we provide components that go into these imaging equipment that OEMs make.

And these are capital equipment. So, what triggers purchase of capital equipment is availability of capital budget by the -- in the healthcare organizations. So, in terms of modalities, first of all, as we said, CT has continued to stay active and strong through the whole process. We've seen this now throughout the year.

In fact, during the height of the pandemic in the third quarter -- in the second quarter, we saw a bubble demand in CT. So -- and then CT is still continued on. So that's -- that was our projection, as you recall, that CT is the versatile modality. And there's a significant demand for CT globally and in the emerging -- including the emerging markets.

So that has continued on. Radiographic saw a bubble in demand. It's – you know, it will settle down to some normal levels, but that was a bubble. Where the significant drop-off for us has been, has been in oncology, cardiology, dental.

These are what we -- and mammography. These are what we've been calling as elective procedure modalities. There, it's encouraging to see that the volumes are -- the procedure volumes are slowly ticking up in hospitals. That's great.

And our customers are also making those comments that they're starting to see surgery volumes and, you know, cap volumes and dental, and they're seeing that uptick. The question is -- for them is when does capital equipment purchasing return to what used to be, let's say, in 2019-type of a normal? There, the story is by geography. What we're hearing from our customers, and it's probably consistent with what -- hopefully, it's consistent with what you're hearing as well, is certain markets, like China, came back fairly rapidly, and China's headed back toward some, you know, flavor of normalcy. Rest of Asia is a little behind that.

Europe is starting on its uptick, and people are confident that the markets in Europe are – now, they're starting to see tender activity, quote activity, but there hasn't still yet been major buying activity. And the U.S. is the farthest -- actually, U.S. is behind that, followed by Latin America, which is the farthest behind.

For us -- for our customers -- most of our customers, the U.S. represents this -- the largest market for high-end products. And the rest of the rest of the countries, emerging markets, while they're coming back, there's -- for us, it's still, you know, some amount of value segment products. So, a lot depends on the recovery -- the speed of recovery is the part that's unknown.

Larry Solow -- CJS Securities -- Analyst

Right.

Sunny Sanyal -- President and Chief Executive Officer

I hope I gave you enough color. So, for us -- we'll proceed by geography and by modality.

Larry Solow -- CJS Securities -- Analyst

And any visibility? You mentioned sort of, obviously the knock-on effect. OEMs will only spend if the hospitals have demand. Even with, you know, hopefully, you know, continued improvement in procedures. Obviously, hospitals will probably remain under pressure until COVID, you know, is not really an issue anymore, which unlikely will happen in the next, you know, six to 12 months.

So, is there a possibility where hospitals are financially under a lot of, you know, pressure, so budgets remain well below normal for an extended period of time even in a post-COVID world?

Sunny Sanyal -- President and Chief Executive Officer

Larry, that's possible. We don't have -- I mean, unfortunately, our crystal ball on that is marquee. However, given that our customers conduct business globally, we think that won't be a global story. I think global -- there will be a lot of variability in how that plays out globally.

So, the budgets are also not entirely hospital-based budgets, right? So, mammography, there's a lot of outpatient budget. Physician offices in a dental -- most of the dental equipment goes into physician offices. So, it's -- we will see a ratcheting up of modality-based capital equipment purchasing versus a light switch being going on. So, we're staying very, very close to this.

And as you know, we're ahead on the value chain, on the supply chain front. So, I'm optimistic that we will see some of these trends perhaps a little bit earlier than you may -- than the actual shipments of equipment.

Larry Solow -- CJS Securities -- Analyst

OK. OK. Fair enough. Just a quick question, just a little more on the gross margin.

Clarence, you mentioned, you know, the two drivers of the drop, obviously, mix and then on sort of overhead. You know, the decremental margin, I think, sequentially was like 70% or something. So even higher than I thought it would be because I know Q2 was already somewhat impacted by mix. It sounds like this quarter was probably worse.

Just trying to -- if you had to bucket those two categories, was it more of the mix that led to that 70% contraction? Or, you know, is there overhead or both close to even?

Clarence Verhoef -- Retiring Chief Financial Officer

Yes. Larry, if you don't mind, maybe I'll just go through a little bit of a walk from last year's gross margin of 34% to the 26% non-GAAP gross margin. I might be able to clarify that, OK? So, you know, there was -- even though we did some significant adjustments that were treated as non-GAAP, there was also some items that were adjustments of one-time in nature, but they did not get treated as non-GAAP. And that would have been some additional inventory reserves based on changing volume profile.

Some revaluation of some assets end up being an expense on the P&L that is not treated as a non-GAAP. And then we also had an increase in freight and tariff costs, somewhat – you know, I mean, mostly, I'd say the freight is a lot of intercompany movement of freight because -- and inbound freight. So those costs have gone up recently. The combination of those onetime kinds of events is roughly three points to gross margin.

The lower productivity just -- and less overhead absorption. And I would put Santa Clara a little bit in the mix of that as well. Complicating it is probably about two points. And then the remaining balance of the eight-point swing is three points of change due to mix.

That's going to be the last part of it. So, I guess it's more important is that three points is tied to mix, but the other five points is, let's call it, some fairly unusual things, either tied to volume or tied to onetime events.

Larry Solow -- CJS Securities -- Analyst

OK. That's useful color. Just last question on some of the products, you guys are getting -- markets you're exiting or products you're exiting. Is this more on the detector side or I think, you know, it seems like that some of that lower-end stuff was impacting your gross margin over the last few years, and would these products actually losing money.

Sunny Sanyal -- President and Chief Executive Officer

Yeah. So, these -- Larry, these are mostly detector products. These -- as you know, these are electronics products with more frequent upgrades and models and faster NPI cycles. So, we looked at our older products that have replacement products for them, and we took this opportunity to go back to the customers and work with them to get them to, you know, a variety of different actions, which led to us deciding to shut them down.

And that will help us with our productivity and cost structures in the future.

Larry Solow -- CJS Securities -- Analyst

So, it's more a rational of your SKUs as opposed to actually exiting the whole product line, just narrowing it.

Clarence Verhoef -- Retiring Chief Financial Officer

That's exactly right. So fundamentally, just because of -- as we looked at the outlook based on the lower demand associated with COVID, it actually made us look at these products and say, is there enough volume there to be worthwhile and then made the determination there not. I would say, generally speaking, they were not losing money products, but they were very low-margin products. I think that's the other kind of key point is that it should help us a little bit on the margin profile going forward.

I'm not sure it's a huge impact, but I think it does help a little bit from that perspective.

Larry Solow -- CJS Securities -- Analyst

OK. Great. Thanks, again.

Operator

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

Anthony Petrone -- Jefferies -- Analyst

Thanks, again. And I'll second the friendly departure of the Clarence. It was great working with, you and welcome, Shubham, to the group here. Maybe to pick off on the last one questioning would be, is there a revenue run rate on the discontinued products? I don't know if you mentioned what the actual revenue run rate? And how much of that is reflected in the $155 million to $170 million guidance for the fourth quarter? And I'll have a couple of follow-ups.

Clarence Verhoef -- Retiring Chief Financial Officer

I don't have an exact answer for you on the number of the revenue associated with those products, but it's low. It's -- that was part of the reason they're discontinued is because they are low-volume, low-margin kind of products. And so, it's -- I'd just say that it's in the – you know, I'm going to speculate a little bit that it's in the $5 million a quarter or less than that kind of a number. So, I mean, it's a pretty small impact on that.

So I don't think that was a major factor in anything in terms of the outlook for the -- for Q4.

Sunny Sanyal -- President and Chief Executive Officer

Anthony, a lot of these cases, because there are subsequent models of the products, in a way, it evens out our -- with the lowering of volumes through the -- due to COVID, we can -- we -- it gives us the extra time to work with these customers to get them to execute our sunset, end-of-life strategies here. So, there wouldn't be a customer loss. There's not a revenue stream loss. These are typically products that go back into the installed base of our customers for low volume, service, and support.

And, you know, opportunity is to work with our customers to have them to take on the newer models.

Anthony Petrone -- Jefferies -- Analyst

No, that's helpful. And then if we – and that's a helpful background there. But if we adjust even $4 million or $5 million number in 4Q, you have a $10 million range in the guidance next quarter. And I'm just wondering, you know, when you think of the low end to the high end, what are the drivers in the spread of that range? You know, what gets you toward the high end as opposed to the low end? And then maybe just broadly, as -- and I know we pressed on it a bit here, the -- just the sort of the tone from OEMs, as you discuss with them where, you know, capital budgets sit for hospitals in the various geographies and what you're exposed to? And then I'll have one capital question to follow-up with.

Sunny Sanyal -- President and Chief Executive Officer

OK. So, let me take the second question around the tone from the OEMs, and I'll ask Sam to comment on the $155 million, $170 million and his thoughts on what makes the $150 million and what makes the $170 million. You know, the tone from the OEMs is optimistic, but there's still some level of uncertainty there. So, you know, I'm cautiously optimistic.

The reason for that is that they are seeing in -- for certain modalities increase in tender activity. For them, that's the early -- the harbinger of the market activity is returning. Some part of that is due to investments by governments in different countries all over the world. Some part of it is just general return to normal in some of the outpatient-type of environments, particularly dental.

Dental activity has started the market activity, tender activity. So, the OEMs are -- while they're not saying that they have bottomed out, they also don't think that the bottom is very far away. So, we're in sort of in asymptotic mode of getting toward the bottom from where they believe this will tick back up. And that said, the time frame, when does it get back to a 2019 type of level? That is the part is not clear with us.

But as we look forward, Anthony, from Q2 into Q3, as we looked at Q3, haven't just felt -- it felt -- it was pretty clear that there was a downward trend. Now, as we look forward, we see, you know, at worst flattish, but it's not quite there yet. But the momentum certainly feels to the market that it is on the positive trend. Now as I said, that varies by geography.

Most of our OEMs are concerned about the U.S. market. And so, if you listen to the – you know, into the OEMs that are in the mammography, oncology, dental, space, they all count on the U.S. market for the high-end products.

Sam Maheshwari -- New Chief Financial Officer

Sure, Anthony. And I'll try to address your question on the lower end versus the higher end of the revenue as we project for Q3. You know, there's always a portion of our business in the quarter, which is a book and ship for the same quarter. So that really depends upon the level of activity in the third month, particularly toward the last two or three weeks.

We are definitely seeing pockets of activity here and there, which are strong, but at the same time, some geographies and modalities are somewhat soft. So, in order to come up with a guidance number for you, we kind of looked at it and kind of book-ended both the numbers that way. Then, on the industrial side, as you know, some of our products are higher ASP, higher machines. And one of the machines is dependent -- it depends upon factory acceptance and that type of activity before it ships.

And it is kind of looking at shipment toward the end of the quarter. So, whether it falls in this side of the fence of the quarter or the next quarter. So that also changes the numbers a little bit. I think I would say, overall, that's where we are in terms of, you know, providing the revenue guidance to you.

Sunny Sanyal -- President and Chief Executive Officer

And Anthony, back to your question on revenue, and also just to add to Larry's earlier question, we shouldn't forget that we also have a strong play in industrial. On the industrial side, the dynamics are slightly different. They're not dependent on the hospital capital budgets. And that's why we like the industrial market.

So there, the recovery is expected to be more rapid because it's distributed across a very large number of organizations. The difference in industrial is that it varies by vertical quite a bit. So, while we may all -- I mean, everyone would say that the airports security will take longer to recover, airport and cargo security. But on the NDT side, we expect faster recovery than the security side.

Anthony Petrone -- Jefferies -- Analyst

And just to round out there, on disruptive testing, you expect a more rapid recovery, but airport security cargo will take longer. Is that the take?

Sunny Sanyal -- President and Chief Executive Officer

Those are tender-driven, yes. And airports are -- as you know, airports are -- it will be a while before business travel, volumes pick up. And so it's -- while the value proposition there is not gone, the activity -- there's still -- by the way, there's still replacement activity that will come back sooner. But the new projects and the new tenders for installing new CT scanners at airports will depend on people's ability to do the project.

The number one thing we hear from OEMs is projects are on hold because there's no one to do the work either on the customer side or on the vendor side. So, which gives the state that it hasn't gone away. It's just that people are waiting for the opportunity to be able to do these projects.

Anthony Petrone -- Jefferies -- Analyst

Understood. And the last one for me, I'll get back in. As you mentioned, same on the debt covenants being potentially tripped here, and we'll see more information on the upcoming filings. I know the convert part of the proceeds were used to service the existing debt.

Can you give a little bit more color on, you know, which facilities we're talking about here, there was a term facility that was outstanding. There was a revolver. And now, we have the converts. Just where the trip up comes from? And when you think of sort of a potential violation of a covenant, you have additional debt coming on, but also the trailing 12-month EBITDA is stretched here.

So, you know, how much is actually driven by the additional debt versus the drop in EBITDA? Thanks.

Sam Maheshwari -- New Chief Financial Officer

Sure. Yeah. Thank you, Anthony. Yes.

So, we have debt, and you rightly correctly pointed out. The debt that we are talking about here is related to term loan and our revolver. Both of them are actually following the same covenants. And these covenants are not related to the convertible debt that we issued in June.

So, what we are talking about here is, again, the combination of debt and revolver. The revolver remains undrawn, but nonetheless, the same set of covenants apply. So, as we look at the debt and the EBITDA over the trailing 12 months, you know, we met all the covenants at the end of Q3 -- fiscal Q3 quarter here. But as we forecast our numbers, we are looking at the situation that we may not be able to meet those covenants.

So, what happens in this type of a situation is that accounting standards required to disclose this, the business as a going concern, irrespective of our ability to refinance or modify those covenants. But our plan is to go ahead and replace these lines of debt with new sources of debt, essentially replace these debts with new sources of debt.

Anthony Petrone -- Jefferies -- Analyst

That's helpful. Thank you.

Operator

Our next question comes from the line of Suraj Kalia with Northland Securities. You may proceed with your question.

Suraj Kalia -- Northland Securities -- Analyst

Good afternoon, everyone. So, Clarence, it was a pleasure working with you, and wish you a relaxed and healthy retirement.

Clarence Verhoef -- Retiring Chief Financial Officer

I'm already relaxed.

Suraj Kalia -- Northland Securities -- Analyst

I'm sure. Sam, welcome to the club. Look forward to working with you.

Sam Maheshwari -- New Chief Financial Officer

Thank you.

Suraj Kalia -- Northland Securities -- Analyst

You know, Sunny, let me start out with you, and then I'll hop over to Clarence and Sam. You know, as COVID might have accelerated some changes that you were thinking about, Santa Clara and so on and so forth. But let me ask a higher-level question. What part of these changes implemented in the short-term or that are acute right now? Do you envision becoming more permanent in nature? And why?

Sunny Sanyal -- President and Chief Executive Officer

Sure. Suraj, I just want to make sure I followed your question appropriately. We took certain actions earlier on that were temporary, the furloughs, pay reductions. Those were temporary actions for immediate relief from -- just to improve our cash flows.

But the rest of the actions that we took were intended for permanent effect. So that's -- and so those are -- so for example, the headcount reduction actions that we took, you know, we took a sharp look at all of our -- I mean, we've been looking at our cost structure. And our intention was to -- these were actions that we would have continued on. We -- with COVID, we -- there were some certain things that came on earlier, like, for example, the product rationalization.

You know, we gave -- we had an opportunity due to COVID, due to slowdown in certain volumes, to go back and work through those product rationalizations. But this is in a series of actions that we will continue. The product life cycle actions will continue on. The cost reduction actions on the -- were permanent.

We will see the effect of -- some effect of that in Q4. It will ratchet up. And then going into Q1, that will continue to increase. The overall run rate impact of all these actions is about $25 million, and they'll ramp up.

And we'll see the full value of that, I believe, Sam, in Q2?

Sam Maheshwari -- New Chief Financial Officer

In Q2.

Sunny Sanyal -- President and Chief Executive Officer

Did I get your question right?

Suraj Kalia -- Northland Securities -- Analyst

Maybe -- Sunny, maybe I should have phrased it differently. I guess ,what I was trying to understand is one is the cost impact, right, cost savings changes that were done. But what is -- I just want to make sure that the main effect of all of this on the revenue, it's not like you're going to reduce some people, and hence, top line is also going to get affected. That's really what I was trying to understand that where it's -- the structure has been optimized.

Sunny Sanyal -- President and Chief Executive Officer

That is correct, Suraj. We -- our goal is to run the company for the long term. So, the product -- we looked at what's going on and said, did this fundamentally change our strategy? Is -- does our entire strategy needs to revisit it there? The answer is no. So the R&D programs, the sales and marketing-related work that's going on, the local-for-local strategy, and the investments that we're making in China, and the setup there, those things have -- we've made sure that those are not -- our ability to continue on with those programs and actions are not impaired.

So, the revenue -- by the way, our customer relationships are absolutely still stellar and exceptional. The product launches are still going on. And by the way, our customers are also working. Even though they're hurting from COVID, their new product introduction actions are still continuing.

So those things have stayed on track. And now, it's purely a matter of the market-driven buying activity, which will drive both the topline growth and the return of the mix back toward normal. And so, as we look at that, Suraj, we're hard-pressed to see how dental won't come back. People need dental services.

The dental equipment that's driving some of the fundamentals of the clinical side of this, those are all still intact. Similarly, the procedures for us, where the higher-value procedures around oncology, cardiology, those are bound to come back. So, we don't see the revenue being impacted. We're not -- commercially, we're not going to be impacted by the actions we've taken.

Now, it's all market-driven activity.

Sam Maheshwari -- New Chief Financial Officer

Suraj, I can add a little bit with my one or two weeks here is that the actions that we are taking do not impact the long-term growth or our ability to recover from the low levels that we currently are. So, these headcount reductions no way jeopardize or compromise our growth potential in revenues. So, I don't know if that's what you were asking.

Suraj Kalia -- Northland Securities -- Analyst

No, fair enough. OK. Sunny, you mentioned about buying -- customer buying. I guess, have inventory ordering patterns changed in the last few months? Are customers asking for more lenient credit terms? Just trying to understand how the demand chain is, you know, -- is shaping up, specifically on the inventory side and on the credit side, whether you guys are seeing any difference right now.

Sunny Sanyal -- President and Chief Executive Officer

So, Suraj, there's been no real – it has not been perceptible at all. No changes in the customers asking for terms or whether it's for their cash preservation or other needs. In fact, our DSOs remained strong at 58. It hasn't changed.

And our collections have remained strong. So, no impact there at all. What we've seen though is in some pockets where customers -- and these customers do this throughout the year. When they perceive a slowing down of demand, they try to deplete their own inventory and buffers, and they worked that down.

And that precedes our -- softness in our demand. So, customers are doing that. They're being more judicious with their inventory, mostly as being conservative, but no changes in anything else. And we've not had to go back and negotiate pricing on those kinds of activities have not been happening.

Suraj Kalia -- Northland Securities -- Analyst

Right. And I guess, last two for, you know, any one of you. One is -- you know, Sunny, Sam and Clarence, most of the companies on the earnings call have come out and said, look, we are expecting a normalcy by calendar Q4 or calendar Q1 next year, you know, whether a V-Shape or a U-shape. I'm not -- maybe I missed your commentary in terms of how you guys are expecting the recovery part? So that's one part.

And the second thing is, I know the Q4 guidance, people have tried to parse it different ways. Maybe I can come at it from a different angle, Clarence and Sam. Should I -- am I fair in assuming that medical is going to be down double digits, you know, probably 15%? And industrial is going to be down another 25%, 30%. Is that the right way to think? I guess just trying to understand on your low end, your high end the different components of the business? So, any color there would be great.

Gentlemen, thank you for taking my questions.

Sam Maheshwari -- New Chief Financial Officer

Sure. You know, I'll go here. And then probably, Sunny, you can fill in some of the -- provide some other color. So, you know, we are quite sure business levels would recover.

And, you know, what we are doing in the meantime is to take cost action so that when the business does recover, we are able to generate more profitability. You know, it seems to us and in our discussions here is that business has gone down, but it is not going down much more anymore in the sense it has stabilized at a lower level, but it has stabilized. We don't really know exactly when it would recover. So, it's very hard for us to pinpoint a quarter.

But we are not seeing a whole lot of degradation anymore. That's where this range of, you know, $155 million to $170 million that we are providing. So, at the midpoint, let's say, $162 million, $165 million. That's the type of number.

And we just did $170 million. So, the businesses somewhat stabilized at the lower level, but really hard for us to pinpoint and kind of guide you to a quarter where we would be able to see a sharp recovery here. So that's the color I can provide you. Maybe, Sunny, you want to add.

Sunny Sanyal -- President and Chief Executive Officer

No. And I'll just add one more thing. So, Suraj, we have -- we served global OEMs and local OEMs. And the global OEMs benefit from the trends in all the different geographies.

So, the question of when they expect recovery to start varies by who you speak with. So, for example, our Chinese OEMs will say their recoveries have begun, and that's reflected in our business in China. And I'm happy to say, by the way, our China business is going well. And I'm glad to see that our strategies have panned out there.

Then as you look at other OEMs, they'll be mixed. They'll tell you that certain markets are recovering faster. So there, their view of where the bottom is might be earlier than, let's say, their view of where U.S. and Latin America is.

I think Latin America seems to be on everyone's pessimistic list versus the U.S. is on next in line after Europe. So, I think this is very -- there's gradations here. And since we have -- we're -- as one of the market-leading companies here serving most OEMs, I think we will end up -- my sense is we will end up being more -- our performance will be indexed to the overall market, so to say.

I'm just – I'm more optimistic that we will see a more -- I -- in certain industrial verticals, I'm hoping to see faster recovery, particularly NDT. But in medical, it will be really by geography.

Clarence Verhoef -- Retiring Chief Financial Officer

Hey, Suraj. One other comment because you were talking about comparisons probably versus Q4 of a year ago, I think that's probably not the right comparison. You probably need to be more thinking about how things look versus the Q3 that we just finished. Because the comp is that Q4 of a year ago, we were $202 million of revenue.

$50 million of that was in Industrial. So, it's a little bit of apples and oranges. And I think it's more important to think of it that as Q4 being more similar profile to Q3 in terms of the mix between medical and industrial.

Suraj Kalia -- Northland Securities -- Analyst

Great points.

Operator

Our next question comes from the line of Jim Sidoti with Sidoti & Company. You may proceed with your question.

Jim Sidoti -- Sidoti and Company -- Analyst

Good afternoon. Can you hear me?

Sunny Sanyal -- President and Chief Executive Officer

Yes. We got you.

Jim Sidoti -- Sidoti and Company -- Analyst

Great. Great. So, Clarence, it feels like you did all the work now and you're leaving. You're leaving Sam within the easy part of it.

Clarence Verhoef -- Retiring Chief Financial Officer

That's right. I set everything up for him.

Jim Sidoti -- Sidoti and Company -- Analyst

Santa Clara, is that officially closed at this point?

Clarence Verhoef -- Retiring Chief Financial Officer

No, no. It won't completely be closed till the end of the quarter in terms of production. There's still some finishing up of a few products where we had some inventory -- carried over inventory that we want to finish those products up. And there's -- so it won't fundamentally complete until the end of September.

Jim Sidoti -- Sidoti and Company -- Analyst

But by fiscal 2021, though, you should have the cost savings for the entire year.

Clarence Verhoef -- Retiring Chief Financial Officer

Yes.

Jim Sidoti -- Sidoti and Company -- Analyst

You will. OK. And then same thing with the workforce reduction...

Clarence Verhoef -- Retiring Chief Financial Officer

Once -- this is a little bit about the accounting around it. So once the production stops, then it's no longer an operating facility in any kind of final cleanup costs. And, you know, those kinds of things that have to be done will be treated as a non-GAAP expense as part of the restructuring charges that we've already set aside for.

Jim Sidoti -- Sidoti and Company -- Analyst

OK. And similar with the workforce reduction, I mean, you'll really see the benefit of that in fiscal 2021?

Clarence Verhoef -- Retiring Chief Financial Officer

Yes. I mean, you hit a little bit of the benefit already, but it's happened in the latter part of July. So, you only got a couple of months in the fourth quarter. But, in reality, when you get that benefit is in Q1 of FY '21.

Jim Sidoti -- Sidoti and Company -- Analyst

OK. Now, you know, I'm -- I agree with some procedures and the names I covered, procedures started recovering, you know, were up actually for most of the names in July. So, I think the timing for the medical business -- I'm confident the Medical business comes back over the next couple of quarters. So with the industrial business, not as confident on the timing of that.

You just indicated that was a $50 million business a year ago. And the NDT will probably come back relatively quickly. But how much of that business was the airport security and the oil pipeline inspection? How long do you think before those pieces start to come back?

Sunny Sanyal -- President and Chief Executive Officer

So, in relative terms, without going in actual numbers themselves, oil and gas is fairly small for us at this point. You remember, it's a new vertical for us that we decided to break into with the acquisition of a small company called BMI. So, we're in that sort of entering early growth phase in there. The bulk of our business comes from NDT and in many verticals.

So, for example, as you think about recovery, think about food inspection, electronics inspection, aerospace, automotive. So, there are a number of verticals where the recovery will happen at a different pace from airport and oil and gas. So that's why we have -- we are anticipating that parts of industrial will recover sooner. And some parts of that will -- might take longer to recover.

In the upcoming quarters, we'll get better visibility to how that is progressing.

Jim Sidoti -- Sidoti and Company -- Analyst

Do you think over the next 12 months? I mean, do you see any reason why that business wouldn't get back to 2019 levels in 12 to 18 months?

Sunny Sanyal -- President and Chief Executive Officer

Boy, that's hard to say, but we will -- I would hope so. Because think about this. I mean, a lot of the consumer-facing areas of Industrial, those will just have a little blip and come back. So, food inspection.

We have people at process fish that process food grains that use X-rays for inspection. They just took a blip phase during the acute phase of COVID, and they're -- that's needed. Frankly, the one vertical that is the slowest is -- the two verticals, airport security and oil and gas. Those are the two that I -- if at all, they'll be trailing those two.

And when we start seeing activity there, that's TBD.

Jim Sidoti -- Sidoti and Company -- Analyst

OK. All right. And then last for me. It sounds like the issue with the covenant is that you'll have to do some kind of refinancing, maybe slightly higher interest rate.

But it doesn't sound like you're worried about having any liquidity issues over the next 12 months. Is that right?

Sam Maheshwari -- New Chief Financial Officer

That's correct. We are working on refinancing. Of course, I would like to see that refinancing complete. But we've been working on it with our partners and advisors.

So yes, until it's done, I'm always somewhat a little bit worried, but that's not a big worry.

Jim Sidoti -- Sidoti and Company -- Analyst

OK. All right. So, like I said at the beginning, I think Clarence left you in pretty good shape, Sam. So, Clarence, it's good working with you, and good luck on your next adventure.

Clarence Verhoef -- Retiring Chief Financial Officer

Thank you.

Operator

Our next question comes from the line of Mark Strouse with JP Morgan. You may proceed with your question.

Mark Strouse -- J.P. Morgan -- Analyst

Yeah. Thanks very much for taking my questions. And I'd like to echo best wishes to you, Clarence. And Sam, welcome to the fray.

Just one point of clarification for me. I'm sorry if I missed this. The greater than $25 million cost reductions you're talking about now, is that building off of the comments from last quarter, where I think you were talking about $15 million to $20 million then? Or is this entirely incremental?

Sam Maheshwari -- New Chief Financial Officer

Yeah, it is. It is including benefits from the Santa Clara facility. So, I talked about $15 million in -- on that set of actions, and then we also reduced the number of people. So that's $28 million.

And there are a few other things that we have in the hopper here. So, we are thinking, you know, we may be able to do a total of cost reductions upwards of $30 million. And all of them are in play. Not completed, but definitely begun.

We feel good about those plans. I did rough math on that. And about 3/4 of that flows through the cost of sales line and a quarter of that, 25% of that, would flow through opex. So, I think it might be prudent here to kind of give you an idea where we are kind of targeting the opex to land at.

So, by the time all these things are done, I am thinking, say, $44 million, $45 million a quarter type of non-GAAP opex run rate we would be able to achieve. And I think we would be able to get there by Q2 of 2021. So, the actions in Q4, Q1, et cetera, that will reduce costs a little bit, but the full effect will begin to print from Q2 of 2021. So that's where we are trying to land this in six months' time frame on the opex side.

And then, of course, on the gross margin side, these cost reductions should give us roughly about, you know, three percentage points. We're going to start getting some of these benefits little by little in the upcoming quarters. But Q2, they should begin to print in the gross margin also.

Mark Strouse -- J.P. Morgan -- Analyst

OK. And then – thank you, Sam. With changes in management, I always like to hear why people decided to join. So, I know we're buttoned up against time here, Sam.

But can you just give kind of your quick elevator pitch on why you decided to join Varex?

Sam Maheshwari -- New Chief Financial Officer

Yes. I think the biggest draw for me was the industry in which Varex is, you know, particularly healthcare, long-term sunshine industry, so to say, growing. Everybody would need healthcare providers, etc. And then the leadership position.

And I looked at the X-ray capabilities. In my mind, X-ray would always be needed. And there are so many other applications for X-ray just medical and also industrial. And then the last thing I did see, during my discussions, you know, there is a potential here to kind of improve profitability and do some good work here.

So those were some of the draws that brought me in here.

Mark Strouse -- J.P. Morgan -- Analyst

Great. OK. That's it for us. Thank you very much.

Sam Maheshwari -- New Chief Financial Officer

Thank you, Mark.

Operator

Our next question comes from the line of Joseph [Inaudible] with [Inaudible] You may proceed with your question.

Sunny Sanyal -- President and Chief Executive Officer

So, operator, we're at the top of the hour. We're past our time. So, I think this will be the right time to end the call.

Operator

OK. Then I would like to turn back over call to you for closing remarks.

Howard Goldman -- Director of Investor Relations

Thank you for your questions and participating in our earnings conference call for the third quarter of fiscal 2020. A replay of this quarterly conference call will be available through August 26 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 13707029. Goodbye.

Operator

[Operator signoff]

Duration: 64 minutes

Call participants:

Howard Goldman -- Director of Investor Relations

Sunny Sanyal -- President and Chief Executive Officer

Clarence Verhoef -- Retiring Chief Financial Officer

Sam Maheshwari -- New Chief Financial Officer

Larry Solow -- CJS Securities -- Analyst

Anthony Petrone -- Jefferies -- Analyst

Suraj Kalia -- Northland Securities -- Analyst

Jim Sidoti -- Sidoti and Company -- Analyst

Mark Strouse -- J.P. Morgan -- Analyst

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