Varex Imaging Corp (VREX) 2018 Q1 法說會逐字稿

Greetings, and welcome to the Varex Imaging Corporation First Quarter Fiscal Year 2018 Earnings 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, Mr. Goldman. You may begin.

Thank you, and good afternoon, and welcome to Varex Imaging Corporation's Earnings Conference Call for the First Quarter of Fiscal Year 2018. This week, we also celebrated our 1 year anniversary since the spin-off and becoming a new public company. 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 year 2018 versus the first quarter of fiscal year 2017, unless otherwise stated. Comparable financial statements for the first quarter of fiscal year 2017 reflect operating results for the Imaging Components business of Varian Medical Systems prior to our separation. Additionally, financial statements for the first quarter of fiscal year 2018 included operating results for the imaging business we acquired on May 1, 2017.

In addition, we supplement our consolidated financial statements prepared in accordance with the U.S. Generally Accepted Accounting Principles, or GAAP, with the use of adjusted or non-GAAP financial measures of certain elements of financial performance. These adjusted measures are not just presented in accordance with, nor are they a substitute for, GAAP financial measures.

These adjusted measures include adjusted gross margin, adjusted operating earnings, adjusted operating earnings margin, adjusted net earnings and adjusted net earnings per diluted share.

We've 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.

We are not able to provide without unreasonable effort a reconciliation of adjusted net earnings to the corresponding GAAP measures on a forward-looking basis due to the potential significant variability and limited visibility of the excluded items discussed.

Please be advised that this discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E (sic) [Section 12E] of the Securities Exchange Act of 1934.

Our use of words and phrases such as expect, outlook, anticipate, will, could, believe, estimate, guidance and other similar expressions are intended to identify those statements which represent our current judgment on future performance or other future matters.

While we believe them to be reasonable based on information currently available to us, these are forward-looking statements 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 filings with the SEC. 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 because of new information, future events or otherwise.

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

Thank you, Howard. Good afternoon, and welcome.

We began fiscal year 2018 with a 12% increase in first quarter revenues, but this gain was somewhat softer than we had anticipated. Acquired imaging business performed well and revenues exceeded our expectations. At the same time, we had a decline in sales from several digital detector customers as they managed inventory levels to better match the timing of their shipments to later in the year, which also led to a lowering of the margin rate. This change in digital detector sales to certain customers is not unusual for our business as we see quarterly fluctuations from time to time for a variety of reasons.

Looking forward with more than 85% of our anticipated revenues for the year identified by current customers -- customer-provided orders and forecasts, we remain confident in our expectation for full year revenues to grow 13% to 14% over the prior year.

We expect to benefit significantly from the recent U.S. tax law changes. Historically, our tax rate was near the maximum rate. Now based on the new rates, along with items specific to our business, we currently estimate that our effective tax rate for fiscal year 2018 will be in the range of 24% to 26%.

This is a great outcome for us and our shareholders. The next question then is, what do we do with the proceeds from a lower tax rate? Our plan is to deploy these gains on investments that provide us long-term returns.

Let me outline what we're thinking. First, we plan to increase investments in technologies that will accelerate innovation, particularly in the areas of CT tubes and digital detectors. The opportunities to expand our portfolio may be organic or inorganic and should further enhance our role as an innovation leader in the X-ray imaging industry.

Second, we plan to increase capital investment on equipment and automation to improve quality and enhance productivity as well as to expand capacity to meet increasing demand for our products in China and other markets around the world.

Third, we plan to invest in our employees. We're still working through the details, but investments here could be in the form of changes to compensation programs, improved health and wellness programs and other benefits tailored to local and regional preferences.

Overall, we're pleased that the reduction in taxes enables us to make these additional investments, which we believe will provide us long-term returns.

Next, I'd like to talk about the global imaging market, look at the near-term growth opportunities and highlight some of our product activity in the quarter.

The global market for medical imaging systems is expected to grow approximately $37 billion by 2022. X-ray imaging comprised of CT and diagnostic imaging systems is by far the largest sector, followed by ultrasound and MRI systems. Major factors driving worldwide growth for our Medical Imaging systems includes increased demand for early-stage diagnosis of chronic disease and an aging population. Technological advancements coupled with supportive investments by governments, especially in developing countries such as China and India, are also expected to contribute to market growth.

The global market for CT scanners is expected to reach $4.5 billion by 2022, representing an annual growth of approximately 4% to 5%.

At the component level, we expect our growth rate to be higher because we sell CT tubes not only for new imaging systems, but also for periodic replacement in the global installed base.

As discussed previously, we continue to see increasing global demand for our CT tubes and related components, particularly in emerging markets such as China where new local OEM customers are reaching late stages of development of their new CT imaging systems and moving into the regulatory approval phase.

Typically, it is around this stage when customers enter into supply agreements with us as they look ahead to the launch of their new systems.

In the first quarter, sales of our CT tubes were consistent with the prior year quarter. Additionally, during the quarter, we added 2 new 3-year agreements for our CT tubes in China valued at a combined $18 million. This brings our -- up to 4 multiyear agreements to date with an aggregate value of nearly $120 million over their respective 3-year lives. Two of these agreements include our CT packages that we launched last year. This new integrated CT solution incorporates a CT tube, generator, heat exchanger, high-voltage connectors and control softwares that are optimized for performance and rapid integration to help accelerate customers' time to market.

Moving on to some of our other products. We are a key player in several X-ray imaging specialties such as 3D dental, mammography, surgery and veterinary imaging. Let me give you color on a couple of these.

The global dental implant market that utilizes 3D cone beam CT imaging technology has been one of the fastest-growing segments in dental imaging and is projected to reach approximately $1 billion by 2022. We are a market leader in this sector and our customers rely on our innovation for dynamic digital detectors and software.

In the first quarter, our dental detector revenues declined following a very strong fourth quarter of 2017, during which OEMs launched a sizable amount of new and refreshed dental imaging systems. This is an example of the quarterly fluctuations that we discussed earlier.

The global mammography market is expected to reach approximately $2 billion by 2022, driven by growing adoption of screening programs globally. We have a broad offering of components for mammography including X-ray tubes, digital detectors and computer-aided detection software.

In the first quarter, our mammography imaging revenues increased by double digits over the prior year.

Switching now to the integration of the acquired imaging business. We continue to make progress, and much of what we have accomplished is behind the scenes related to revenue and cost synergies which we have outlined in the past. I'm pleased to report that we remain on track to achieve our $5 million cost synergy goal in the fiscal year 2018. We're proud of the team and their accomplishments thus far.

And lastly, I'm pleased to announce that Victor Garcia has joined Varex as Vice President of Regulatory Affairs and Quality Assurance. He's overseeing all regulatory and quality compliance processes that we are required to follow as a medical device manufacturer.

Before joining us, Victor held numerous senior leadership and advisory positions with companies in highly-regulated environments.

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

Thanks, Sunny, and hello, everyone. Let me summarize the key financials for the first quarter and then I'll go through the impact of the U.S. tax law changes, which will also change our outlook for 2018.

Including the results of the acquisition, our first quarter revenues were up 12% to $176 million. As a point of reference, the acquired imaging business have revenues of $35 million in the year ago quarter, which was prior to the closing of the acquisition.

Medical segment revenues increased 6% in the first quarter to $139 million. X-ray tubes were stable while software and connected control were up by solid double digits. Digital detector revenues grew with the addition of the acquired imaging business, but we saw declines from several customers in the dental and radiographic markets as they managed their inventory levels.

Industrial segment revenues for the first quarter increased 44% to $37 million, almost entirely due to the addition of the acquired imaging business. Shipments of cargo screening systems were lower than expected in the quarter due to customer changes of delivery dates to later in this fiscal year.

For the first quarter, our gross margin was 35% compared to 37% in the prior year quarter. The adjusted gross margin was 36% compared to 38% a year ago. Gross margin rates improved for X-ray tubes, software and connected control products. However, detector margin rates declined due to a mix of lower margin products. Based on the lower margins for the first quarter, we now expect the full year adjusted gross margin rate to be between 37.5% and 38%.

R&D expenses were $20 million or 11% of revenues in the quarter, which has increased from 8% of revenues in the year ago quarter. This increase was due to new dental detector projects and prototype material costs for CT tube projects.

Including some of the investments that Sunny discussed earlier, we expect our R&D spending to be less than 10% of revenues for the fiscal year.

First quarter SG&A expenses were $28 million compared to $27 million in the prior year quarter. Depreciation and amortization totaled $9 million for the first quarter compared to $4 million a year ago. Our operating earnings for the first quarter were $14 million, down from $19 million in the same quarter a year ago. Our operating margin rate was 8% in the first quarter, a decline from 12% in the year ago quarter, reflecting acquisition-related costs and higher R&D spending.

For the first quarter, our adjusted operating earnings were $18 million compared to $23 million in the prior year. The adjusted operating earnings margin was 10% compared to 15% in the prior year.

Interest expense in the first quarter was $6 million compared to $1 million in the year ago quarter.

For the quarter, we recorded a net tax benefit of $4.3 million. This included a onetime net tax benefit of $6.1 million due to the revaluation of deferred tax liabilities partially offset by the recording of the full cost of the new repatriation tax.

Excluding the onetime tax benefit, we recorded $1.8 million of tax expense for the first quarter with an effective tax rate of 25.4%. We continue to analyze the changes in tax law and the SEC guidance on accounting for these changes. We now expect our full year effective tax rate to be in the range of 24% to 26%. Looking beyond fiscal year 2018, we expect the effective tax rate to be a couple of points lower.

Sunny explained the investments that we plan to make with the gains that we get from the tax law changes. A portion of these investments will impact the income statement with additional R&D expense and employee benefits.

Net earnings for both the first quarter of this year and last year were $11 million. For the first quarter of fiscal year 2018, adjusted net earnings were $9 million or $0.23 per diluted share compared to $14 million or $0.37 per diluted share in the prior year.

Diluted shares outstanding were 38.2 million shares versus 37.7 million shares in the prior year.

Now turning to the balance sheet. We ended the first quarter with cash and cash equivalents of $94 million. During the first quarter, we reduced debt by $29 million to $454 million. Cash flow from operations was approximately $40 million and estimated free cash flow was $37 million.

Looking at our working capital. Accounts receivable decreased by $34 million during the quarter due to a lower amount of invoicing. Days sales outstanding was 67 days compared to 68 days in the prior quarter. Inventory increased by $11 million during the quarter.

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

For fiscal year 2018, we reiterate our expectations that revenues will grow by 13% to 14% over fiscal year 2017, including the additional revenues from a full year of the acquired imaging business. We expect that our adjusted net earnings will be higher than our previous guidance due to the lower tax rate, partially offset by a lower gross margin rate and additional investments in employees and product development.

For fiscal year 2018, we now expect adjusted net earnings to be in the range of $1.82 to $1.92 per diluted share.

At this time, we would like to open up the call for your questions.

(Operator Instructions) Our first question comes from the line of Anthony Petrone of Jefferies.

Maybe to start on the quarter and the slippage. And so maybe to clear up one item, was there any OEM contract losses, a? And then, b, it sounds like mostly on the detector side, but yet top line guidance is reiterated. So I'm just wondering, does that assume you're getting back that business in future quarters or is underlying demand strong elsewhere? And then I have a few follow-ups.

Yes. Hey, Anthony, this is Sunny. So the answer to your -- yes, the slippage was due to detectors. There wasn't anything underlying. There were no customer losses. This was largely due to our customers in a couple of segments with the detectors managing their inventory levels. Essentially, we have several customers have year-end in December. And in anticipation of that, they build -- they tend to have large -- big year-ends, and particularly with the launch of new products. We have several customers that launched new products, they had a big fourth quarter, they planned for it with their purchase of components early in the August, September time frame, which was our fourth quarter. And that's it. They're just going through a transition from that -- their fourth quarter to their first quarter, and that's where we saw the softness. We're expecting that to bounce right back. It will come back to normal volumes. And our second half of the year, we expect strong performance in China, and the CT tube side as well. So combining that, we are reiterating our top line guidance for the year.

Hey, Anthony, maybe -- Anthony, let me add just a couple of other comments there just to help clarify that a little bit because I think one of the things that happened is the adjustments came kind of in the middle of the quarter, and so we didn't really have a whole lot of time to react in terms of trying to pull in some other or talk to push in some other business. And so -- but what it was is it really was a timing kind of thing. And one of the key points that we wanted to make was to just make sure that once that was -- we were aware of that, we went through a very detailed bottoms-up roll-up looking at kind of what does the balance of the year look like, in particular, in discussions with those few customers that have made the adjustments. And it came out pretty strong that we would be on track for the full year and we're comfortable that we can have that transition happen a little bit later in the year than what we would have liked. I mean, certainly, we would have preferred to have it in the first quarter. But it'll still happen.

Yes. One more point to add to that. We did have a few shipments that moved in the security side. That's purely timing and it'll -- there's nothing lost there, it'll come right back. These are larger dollar item units. So when they move, they move with quite a bit of revenue with them.

Okay. And then just to stay on guidance, just the earnings guidance. By our math, the core number, the core earnings number is sort of down $0.14 to $0.24. So maybe just reconciling that again, the iteration of top line, you certainly get some back on tax. There's the miss on the first quarter, but you have that core earnings number that's down quite a bit. So maybe just kind of help us bridge that gap a little bit.

Yes. Let me just give you kind of a little bit of a walk basically of kind of what the EPS numbers were. So the previous guidance we had given was $1.78 to $1.88. So let's just use the midpoints. The midpoint of that was $1.83. My number on the impact of the tax is that we gained $0.18 in that. And then that's offset by $0.14, which is a little bit what you touched on going away, which is related to additional investments that we are making in the R&D and utilization fundamentally of some portion of the tax gains and a little bit of impact from a lower gross margin. Fundamentally, the Q1 gross margin was 36.3%, I think. And so that's 1.5% down. And that's -- so I've adjusted the gross margin rate down a little bit to take into account that one quarter is already in the bag at that level.

Okay. Last one...

The math is that I end up with $1.87 as the new midpoint, and that's where we end up with the range of $1.82 to $1.92. Sorry.

Yes, no worries. And the last for me, and I'll get back in, is just looking ahead to '19. Is this the tax range that you would expect? Or being that you have sort of a shift here, the January month, does it change all that much looking into fiscal '19?

No, it's -- so it's a pure math formula to say if you have 35% as your tax rate in Q1 and then 21% as the tax rate for the other 3 quarters, that averages out to 24.5%. Then we have a few other puts and takes that are state tax, foreign taxes, some R&D credits, those kinds of things that are offsetting it. So that's where -- what I mean. And fundamentally, those net pretty well off each other, so we're in the range of 24% to 26%. Next year, that 35% goes away. And so you're down -- you gain a couple of points in there. I would say that there's one item that we get favorable this year that goes away for next year, which is I think called the production manufacturing exemption for domestic production that we get benefit from that. This year, that goes away. So it's a little bit of an offset. So long story, but I basically feel like we're going to be a couple points lower on the tax rate in '19 and beyond.

Our next question comes from the line of Paul Coster of JPMorgan.

So getting a few questions around the contribution from Perkin in 1Q. I know you said it exceeded your expectations, but is there anything more specific you can say? I think people are just trying to figure out what the organic growth or decline was this quarter.

I'll take a shot at that, first of all, which is just give a little explanation. So as I've mentioned, the prior year, just for comparison purposes, was $35 million for them. They did -- for the core business that we can identify, that core business that's comparable to that, they did better than that. The challenge we have is that we have really started to merge the product lines together, so the revenues are much more intermingled. So I can't give a specific about how much the impact was, but I would say that it's a good news story, and that it's not only higher than what it was a year ago, but also just a little bit higher than our expectations as well. Maybe a little bit of other color around that is the integration process is going very well and well on -- is on schedule in terms of things such as IT systems, merging the supply chains and the R&D teams. I think all 3 of those are going very well.

Okay, that makes sense. And then I know you guys don't give guidance quarterly, but is there anything you can say about the cadence of revenues as we progress throughout the year? Just trying to think about how people should model the -- how significant of a second half ramp there should be.

It's a good question. I think -- so one of the things that we're looking at in our business is we've had a little more ups and downs, I'd say, than what we really had anticipated before. We had kind of an okay Q3 and then we had a large Q4 and then an okay Q1, and now we're going to say, what does that mean going for the balance of the year? I would say that we are -- we're a little bit at the mercy of the OEMs and how they manage their business and how they manage their inventory levels and a little bit also of kind of the timing of events for them, whether that's their year-ends or product introductions. Those are all factors that come into play. The -- I would say also, though, that the second quarter, we have pretty good visibility into that, now we're already a month into it. It is very much at the normal levels of what we would -- where we were expecting it to be. So I don't think that's a challenge for us. But I also would say that when we're talking about the growth that we would expect to have from some of the business in China, that is definitely at the back half of the year. That is not the kind of stuff that's going to be hitting us rather significantly in Q2.

Our next question comes from the line of Scott Marx of Samlyn Capital.

Hey, guys, I just wanted to follow up on Anthony's question from before. I think that you just said on the prepared remarks that you're guiding to R&D as a percentage of revenue below 10%, and that's where it looks like The Street models are. So you make it sound like it's an additional expense and offset to the earnings guidance, but it doesn't look like there's much of a difference versus where consensus was. Is that 10% of revenues? Is that potentially going to be higher than that? Can you just explain that a little bit?

Sure. Maybe a little bit of baseline, which is last year, we were 9.5%. And so -- and then the indication I've given for this year was 9% to 10%, and more leaning towards the lower end of that going into the year. Now as we see the gains that we've got a little bit here, we're going to be more at the higher end of that range, so closer to the 10% level. But we don't anticipate going over the 10% level. That was kind of a little bit of kind of -- the intent there was just to give a little bit of some boundaries on it. At the same time, we talked about a half a point movement in that number to somewhat in the range of about $4 million. So it's not an insignificant number for us. So that's -- so that gives you a little bit of color. I'd say it's going to be close to -- more at the higher end of the 9% to 10% rather than the lower end.

Our next question comes from the line of John Koller of Oppenheimer.

It's Oppenheimer + Close. I guess I backed into a CapEx number of about $3 million for the quarter based on comments. Is that the right...

Yes. A little bit shy of that, but that's the right number, yes. You'll see our 10-Q in about a week. That'll give you an exact number.

Okay. And it's okay to ballpark that for the full year on a normalized run rate? Or do you expect some of the tax savings will increase that?

Yes. No, I had said previously we'd be around 2.5% of revenues, so which would be around $20 million or somewhere in that kind of range, a little bit north of that. And now with some additional investments that we're doing, I would say that -- I'd put the number as closer in the 2.5% to 3% of revenues. That will give you a little bit more color as to where the CapEx is. We have got some projects that we will be doing a little more in the latter half of the year as far as that -- as far as CapEx goes.

Okay. And then sort of -- since we're on this topic to back into a type of return that you're expecting on this. Is there a way to quantify -- that you would like to quantify, I guess, whether you expect this to be more capacity driven or cost? And then what kind of rate of return might you be expecting on something like this?

So you're talking about the capital still? The CapEx...

Yes, exactly. Right.

Yes. The -- there's 2 elements to it that we typically have when we look at capital spending. One is there's clearly an element that's around capacity and what we can get in terms of additional product out the door. There's always going to be a certain element of our capital spending that is just maintenance level that is the replacement kind of cycles on products, but there's also some expansion of capacity. And sometimes those come in big chunks, like when you do a facility expansion or something like that or a major piece of equipment such as -- or a clean room kinds of things, those will be in big chunks. Don't anticipate any of those, so I think it's more about augmenting and adding some additional equipment to allow more throughput through the factory. The second part of it is focusing around productivity. So this might be changes that do a little more automation in the process or things that maybe we were outsourcing before that we would insource now. Those are the kinds of things that we'd also be working on. I'm not sure I have a great answer for you about how to quantify the returns on those things because a lot of those, particularly when you're talking about long-term capacity kinds of stuff, it's difficult to put a measure on those.

Okay, okay. To the R&D component, 11%, I guess part of it is that the revenue was down. So as your revenue picks up, I guess you expect to keep that somewhat flat but -- in dollar terms. But I'm just curious, is -- are we thinking that 8% to 9% or 9% is just too low a number going forward and it needs to be higher? Or is this still an escalation of above normal, so to speak?

It's a good question because I think there is a -- I do still feel like that in the long term that we can get some leverage and some efficiencies in the R&D process and the -- at the lower end of that 8% to 10% range. At this point in time, all the activity that we've got going on very specifically for supporting the growth in China, I think that's a key driver for us that is putting us at the higher end of that range. Those things, they come in -- they're not always nice, smooth and steady kinds of things, so you're going to have times when that is going to have a -- an uptick on that. We're at that stage right now, particularly as we're doing a lot of prototype material in that space. And then, I mean, as we continue to expand the product portfolio on the detector side, I think that also is a factor that comes into play at point in time. I still do believe, though, that -- you get leverage as the revenue number grows, but you don't have to have the R&D line grow at the same rate.

Okay. And then again, just to quantify to make sure I understand this correctly. These are things that you are working on, on the R&D budget that are -- where you can reasonably ascertain a revenue attachment. They're not moon shots as it were. You're not just taking a couple of extra million dollars because you have it to go out and spend it, try to hit a home run, so to speak. Is that fair?

Yes, this is Sunny. Hey, these are not speculative investments. These are sort of ongoing new product introductions. And our -- and then we'll drive the new revenue streams that are typically tied to like a new tube launch or new detector launch. So it's part of our ongoing -- to drive our ongoing business and growth that we've forecasted. A very small portion of our R&D, about 10% of our R&D spend, goes into sort of the fundamental R part of the R&D, which is -- but that's a very small amount. And there, we put the money into technologies that then gets used in all those other products that we build with the rest of the R&D dollars. Yes, so there are no large moon shots planned for that RD.

Maybe one clarification there, John, is that the -- even that research is going into enhancements or new technologies for X-ray tubes, detectors, high-voltage cables and software that we make today, so it's not going into a different space. I don't think -- that's not in our charter.

Okay, great. And then just I know historically, you've invested in R&D and then you've received some kind of -- or look at the revenue in 3 years. So it's fair to assume that your return on something like this, if it's a new spend, it's going to be a few years out and we should look at revenue at that point to value a return on this investment. That's fair, too, right?

Yes, 3 to 4 years out is usually the time frame when we start to see some of the R&D turn into products that our customers ship.

Our next question comes from the line of Larry Solow of CJS Securities.

A few follow-ups, I joined a little late. Just in summary, so it sounds like the flat panel detector, the lower sales is purely timing, although you may not catch up quite on a full year basis so you might lose a few cents. Is that fair to say there, and then the offsets to the tax rate is the higher R&D?

Let me address the first one, which is rather than saying lose a few cents because I'm not sure if -- we've held our guidance at the 13% to 14% revenue growth. So I don't agree that we're losing a few cents because we're holding the revenue at the same level.

Well, you said that you raised -- you said the midpoint would be $0.18 up, but you're, right, but you're not quite -- you didn't raise your EPS, right. But then you lost $0.14 of that. So you basically said you -- you're only really lowering on about the R&D and nothing else. Is that correct?

Yes. So no, I think because the other part of that is that the gross margin in the first quarter was a little on the low side, so I think I extrapolate -- or not assume that we would make up all that gross margin...

Right. And that's because of the lag in flat panel -- in the flat panel detector piece tied to that.

Yes.

Okay, okay. And on the R&D side, specifically, it sounds like some of this is opportunistic investments. Is this related to lower tax rates? And I know you guys have, over the last 12 months, launched a bunch of new products out there. Is this an extension to that? And will -- is this something that is short term in nature, this acceleration in R&D? Or is this sort of a new level of R&D that will sort of continue going out over the next few years?

Hey, Larry, this is Sunny. So I'll take the first stab and let Clarence add to it. Essentially, what we're doing is using the -- some gains from the tax rate to add to our R&D efforts to accelerate some initiatives that are already underway. Essentially, derisk some of the work that we're doing. And so instead of taking, let's say, 3 to 4 years, we're trying to pull some of mark-ins so we can get those products out to market faster. But the revenue side of this, it won't show up in 2019 or 2020. It will still be about 3 years out. But we're taking some of the key technology areas where we want to bring out new products and adding some additional horsepower there to bring -- make sure that those will be successful and to make sure that we can pull those in, we will pull those in.

Okay. So it's fair to say that this higher run rate of R&D will continue for the next several years.

Yes, at least for a few years. As Clarence said, we've given guidance saying we'd be between the 9% to 10%. We're now anticipating around closer to the 10% range. But then we don't anticipate continuing to grow it. So as you go into '19 and '20, we're comfortable with the level of R&D that we've planned here. So as a percent of revenue, it'll come down a little bit, but I think -- still think it will be in the 9% to 10% range.

Okay, got you. And then I'll just make one follow-up. Just sticking with the flat panel detector side and the digitalization on that side. Obviously, still I think some controversy on that on what inning we're in and how much more of a real true opportunity there is for you on the profit side there. I realized that some of the lower end markets have not switched over, but maybe the profitability there won't be as high. So I guess, 2 questions to that, do you still see the digitization of the flat panel detector being a tailwind for you? And then, secondly, specifically on the retrofit opportunities, where do we stand there? And is that a much higher margin opportunity, the retrofit side, than some of the other pieces?

I didn't quite catch that...

The retrofit.

Oh, the retrofit side. So the way we've characterized the runway for the digital detectors is there's a combination of new shipments that are converting to digital. And so there, there's still quite a bit of room to grow in that. In about -- only about 50% of the detectors of that are being shipped globally are -- rather, systems that are being shipped are being shipped with digital detectors. So that, over the next 2 to 3 years, we expect that percentage to grow to 50 -- from 50% to maybe 80% over the next few years. But in addition to that, there's also a very large installed base. At JPM, we had given some stats around. We think only about 30% is going into the retrofit space. So there's a long runway of about 8 to 10 years for converting that. Now those are, as you characterized this, mostly radiographic. And within that, there's a high end and lower end. So the margin pressure is on the low end. But the dollar volumes there are quite high. Now in addition to that, the dynamic is that the areas where digitization started early, which is in dental, we're seeing the second generation of those systems come out with newer capabilities, improved performance. There, the pricing has held and the margins are very good. So on balance, I would say, as we go forward, we see -- we're already seeing price stabilization. So there's not that much -- the price erosions are in the mid-single digits range on the detector side. So at this point, we're not anticipating any major shift in the pricing structure or the margin structure for detectors. And the mix of the high end, which includes the dental, the mammography, the high end, the dynamics detectors, those are continuing to be strong. Surgery is an example where they use dynamic detectors. Surgical space is just beginning to convert to digital systems and the runway there is also pretty long. So our anticipation is that we will see a mix of low-margin and high-margin detector business continue as we go forward.

(Operator Instructions) Our next question comes from the line of Anthony Petrone of Jefferies.

Maybe just a follow-up on just a higher level outlook over the next 3 years or so. I think the messaging at Analyst Day in November was sort of this is a 2%, 3% organic growth company. There's still tuck-in acquisitions to be had and operating margins, we'll see some sort of cadence year-over-year with, I guess, an ultimate goal at some point to get to 20%. So is that still a fair assumption as you look out? And then one in particular, just the debt paydown schedule, how should we be thinking about interest expense as we move into '19 and beyond?

Let me take a crack at it first and you can talk about the debt paydown as usual. Hey, Anthony, our expectation is that we have said that long term we're expecting 5% growth rate. The 2% to 3% is going to be -- and by the way, we're sticking with that. That is our forecast, that's our expectation. The 2% to 3% growth rate is being driven by the current business, the current portfolio and the mix of products. As we get traction in China, and we've already picked up quite a bit of orders over the next 3 years that will be delivered over the next 3 years, as that -- as we get traction with those orders and the delivery of those and market penetration increases in China, we're expecting that book of business to contribute to the growth rate. And that's when we expect the top line to get towards 5%. So our expectation is still that we will get to 5% growth rate in the longer term and we're still gunning for the 20%. I think we're from around, what, 15.5% to get to 20% operating margins.

And then let me touch on the questions around the capital structure, I guess. So if I think about net debt, which is the debt of $454 million minus the $94 million of cash on hand, we're at $360 million net debt, which is basically 3x EBITDA today, trailing EBITDA. And so -- and we had a very strong first quarter from a cash flow perspective somewhat because of the lower revenue number, I mean, or the impact of that on AR. But at the same time, I mean, we generated $40 million of cash from operations, which is awesome. The expectation is, is for the year was that we would be somewhere in the range of $60 million to $80 million, probably a little more in the higher end of that range now is kind of the anticipation of what the cash flow is. So excluding any kind of impact from any acquisitions, tuck-in kinds of acquisitions, I -- we'll have a pretty sizable debt reduction over the next couple of years to get us down to probably under 2x EBITDA, somewhere in that kind of range. So I think it's a good positive story from that perspective because I don't think that the little bit of adjustments we're doing on the capital spending is not material from that perspective, and it's more about making sure we have the follow-through to EBITDA, I guess, and such from the top line.

Our next question comes from the line of Larry Solow of CJS Securities.

Just a quick follow-up. On the -- can you just maybe give a little more color on sort of what kind of products on the R&D side? Is it just more of the same? Is it more, yes, I mean, better? But of course -- but I mean that in a positive way. Is it more subset some type of stuff? Is it potentially getting into obviously the same markets, but a little bit a tangent type products? Or can you give us any color on that, that would be great?

It's a little bit of a few different things. But largely speaking, these would be acceleration of applications and products that we're working towards. So for China and for other markets, both in detectors and in tubes. So for example, bringing additional lower-cost detectors to market, next-generation detectors. There are some foundational technologies that we invest in that go, as we said earlier, that go into our tubes and detector products, like things go into the bearings, into the filament technologies. It's -- there's a chunk of that new additional investment that's going to go in there that will help essentially create additional differentiation for us. So we're expecting that this R&D will more likely contribute to (inaudible) some of our products to market and aid in improving the products -- the competitiveness of those products. Hard to quantify at this point for you, but I think we should probably model it the way you already have, which is these are products that will contribute to longer-term growth to get us to 5%. And what we're doing is ensuring and adding additional sort of insurance to it to say that we will get it done, we'll get it done sooner if we can with these additional investments.

Our next question comes from the line of John Koller of Oppenheim + Close.

Just a quick question on the acquisition front. Is it fair to assume that you're not yet out in kicking tires in any serious way? Or would that be a mischaracterization on my part that you're starting to look around at least maybe for smaller things?

Yes. We haven't -- we're not kicking tires any differently. Well, maybe I'll put it this way. We have a fairly -- we're fairly active in the market in a sense that we know our -- the players in the space. We have a BD pipeline that we continuously review and continuously evaluate and assess. So we're just continuing to do that. There's no -- there's been no difference in our activity.

Maybe one thing, John. Maybe one thing along those lines, John, is that time is kind of one of the key elements here because obviously we had a very sizable transaction last year with the addition of the PerkinElmer business. And as we get further along in the integration of that, which is, as I mentioned, it's going well, that starts to free up a little bit of, let's call it, management bandwidth, to actually start to look at these kinds of things. And so we're -- a fair amount of time has gone by. I mean, that closed in May. And so now we're here, not that far away from the anniversary of that, so it starts to change the outlook.

Okay. And from a capital front, if you saw something you liked, you don't feel at this point constrained, assuming it's modestly priced?

Yes. I mean, valuation is always the key, right? So I mean, (inaudible) it's figuring out -- get the right price. But in terms of opportunity and our capital structure, yes, I think we're okay for doing the tuck-ins.

There are no further questions over the audio portion of the conference. I would now like to turn the conference back over to management for concluding remarks.

Thank you for your questions and participating in our earnings conference call for the first quarter of fiscal year 2018. A replay of this quarterly teleconference will be available from February 1 through February 15 and can be accessed at the company's website or by calling 1 (877) 660-6853 from anywhere in the U.S. or 1 (201) 612-7415 from non-U.S. locations. A password is required, and that code is 13675529. Thank you. Goodbye.

This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time. Have a wonderful rest of your evening.