Varex Imaging Corp (VREX) 2018 Q2 法說會逐字稿

Greetings, and welcome to the Varex Imaging Corporation's Second Quarter 2018 Fiscal Year 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, Mr. Goldman. You may begin.

Good afternoon, and welcome. 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 second quarter of fiscal 2018 versus the second quarter of fiscal 2017, unless stated otherwise.

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 presented in accordance with, nor are they a substitute for, GAAP financial measures.

These adjusted measures include adjusted gross margin, adjusted operating margin, 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 unable 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 of the Securities Exchange Act of 1934. Our use of words and phrases such as expect, outlook, anticipate, will, could, believe, estimate, guidance and 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 related to our business are described in our filings with the SEC. The information in this discussion contains -- speaks as of today's date and we assume no obligation to update or revise the forward-looking statements in this discussion because of the new information, future events or otherwise.

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

Good afternoon, and welcome. I'm pleased to report a strong second quarter with significant revenue growth, up 30% from the prior year quarter. For comparison purposes, if revenues from the acquired imaging business have been included in the prior quarter, we would have grown by 5% year-over-year. This increase was primarily driven by higher sales of our products for the CT, industrial and oncology markets. Partially offsetting this was a decline in product sales for the radiographic market.

On a trailing 12-month basis, the strongest markets for our products were oncology, mammography and industrial. CT grew consistent with the global market rate while radiographic digital detectors declined. Our products for the oncology market have performed well over the past year due to what we believe has been an overall market growth for radiation therapy systems, including expansion into emerging markets.

Looking at individual product lines, we experienced strong growth in the second quarter in X-ray sources and connect and control. Digital detectors were on plan and software was down slightly. The acquired imaging business continued to exhibit very good performance and exceeded its revenue plan for the second quarter.

Revenues from dental 3-D imaging detectors returned to historical levels and increased 50% over the first quarter of the current fiscal year. In addition, most of the linear accelerators that were delayed in the first quarter were shipped in the second quarter.

R&D investment in the second quarter was 11% of revenues and above our target range. This was primarily due to the costs of CT prototype materials for Chinese OEMs and the acceleration of certain internal innovation projects.

So in view of this last point, I'd like to take this opportunity to clarify our approach to R&D. Innovation is the lifeblood of our company and one of the key reasons why we have numerous loyal customer relationships that have extended for decades and why we continue to gain new customers around the world for X-ray imaging products. We prioritize our R&D spend into 2 main categories. First, we invest in development projects with OEM customers to build new components for their X-ray imaging systems. During the last 2 to 3 years, a significant portion of our R&D for X-ray tubes has been committed to the development -- developing next generation CT tubes with specific focus on the needs of emerging Chinese manufacturers.

In addition, we continue to develop and bring to market many new connect and control and digital detector products to stay competitive and drive growth.

Second, a smaller part of our R&D budget is allocated to foundational technologies, which is the research part of R&D. These investments in foundational technologies have been a key driver for the performance and differentiation of our products. Examples of these technologies in X-ray tubes are new types of emitters, bearings and materials that enhance heat storage and transfer. In digital detectors, innovation typically comes from the development of new types of detector materials, coatings and application-specific chips.

As these new foundational technologies are proven out and introduced into our products, they improve quality and performance, extend product life and reduce costs. We believe that this type of innovation is not only needed to stay ahead of the competition, but also to convince OEMs who develop components in-house to outsource to us.

In anticipation of savings from a lower U.S. corporate tax rate, we have accelerated certain innovation programs while we also continue to maintain investments in customer-driven R&D projects. This contributed to an increase in R&D spend.

Our sales teams closed several new multiyear pricing agreements during the second quarter. These agreements included approximately $50 million of X-ray tubes and digital detectors for the China market. During the quarter, another pricing agreement for our CT tubes was signed with a Chinese OEM, bringing the total number to 5 agreements to date.

While the opportunity for our CT tubes in China market is a key growth driver for us, it is important to remember that we also provide our Chinese OEM customers several other non-CT X-ray imaging components.

Two days ago marked the 1-year anniversary of our acquisition of the PerkinElmer imaging business. Revenues for this business exceeded expectations in the second quarter, primarily due to increased detectors sales for the oncology and industrial markets. We are on schedule with our integration and continues to be on track to achieve our $5 million cost synergy goal for the fiscal year 2018.

Lastly, I'd like to report that our first annual sustainability report has been completed and filed with the Global Reporting Initiative, or GRI, the most widely adopted framework for sustainability reporting. It has also been posted on our website. The report highlights 4 pillars of our sustainability strategy: inspiring innovation, protecting the environment, empowering people and communities, and acting with integrity.

As we grow our business, we need to do it responsibly, cost-effectively and in a manner that creates value for society while reducing our environmental footprint. We rely heavily on the engagement of our employees and we look to partner with customers and suppliers who align with our priorities. This is what drives us to grow our global business and to do it sustainably. I invite you to read this report and find out more about our suitability efforts.

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. I'm going to focus my discussion on Q2 results, and the year-to-date financials can be found in our press release. I would summarize Q2 as great performance on the top line with some softness in the gross margin rates while the operating expenses and the lower tax rate were in line with our expectations. Additionally, we had higher than expected income from investments in privately held companies.

Including the results of the acquisition, our second quarter revenues were up 30% to $201 million. As a point of reference, the acquired imaging business had revenues of $36 million in the year ago quarter, which was prior to the closing of the acquisition.

Medical segment revenues increased 26% in the second quarter to $159 million. Revenues from sources were up high single digits, connect and control was up by solid double digits while software declined slightly. Digital detector revenues grew not only with additional of the acquired imaging business, but also from good demand in the oncology market.

Industrial segment revenues for the second quarter increased 47% to $43 million, almost entirely due to the addition of the acquired imaging business.

For the second 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. This quarter, the product mix was favorable for detectors and connect and control, but was offset by an unfavorable product mix for X-ray tubes. Gross margins for the industrial segment were lower due to high manufacturing costs and higher deferred revenues.

Based on the lower margins for the first half, we now expect the full year adjusted gross margin rate to be approximately 37.5%.

R&D expenses were $22 million or 11% of revenues in the quarter, which has increased from 9% of revenues in the year ago quarter. This increase was primarily due to prototype material costs for CT tube projects as well as new foundational technology projects. We now expect our R&D spending to be approximately 10% of revenues for the full fiscal year.

Second quarter SG&A expenses were $31 million compared to $20 million in the prior year quarter, which did not include any expenses from the acquired imaging business. In the second quarter, we had approximately $2 million of acquisition integration and restructuring costs, approximately $1 million of higher stock-based compensation expense and approximately $1 million of additional consulting and audit fees for the implementation of new accounting standards.

Depreciation and amortization totaled $10 million for the second quarter compared to $7 million a year earlier.

Our operating earnings for the second quarter were $17 million, down from $24 million in the same quarter a year ago. Our operating margin rate was 9% in the second quarter, a decline from 15% in the year ago quarter, reflecting the acquisition-related costs and higher R&D spending.

For the second quarter, our adjusted operating earnings were $24 million compared to $25 million in the prior year. The adjusted operating earnings margin was 12% compared to 16% in the prior year.

Interest expense in the second quarter was $6 million compared to $1 million in the year ago quarter. We had other income of $4 million in the second quarter, primarily due to the results from investments in privately held companies. Our effective tax rate for the second quarter was 21.7% compared to 33% in the prior year.

Net earnings for the second quarter were $12 million or $0.32 per diluted share compared to $15 million or $0.40 per diluted share in the prior year quarter. For the second quarter of fiscal year 2018, adjusted net earnings were $17 million or $0.45 per diluted share compared to $16 million or $0.43 per diluted share in the prior year.

Diluted shares outstanding were 38.4 million shares versus 37.8 million shares in the prior year. We ended the second quarter with cash and cash equivalents of $55 million. During the second quarter, we reduced net debt by $37 million to $417 million. Cash flow from operations was approximately $4 million in the second quarter and was $46 million for the first half of the fiscal year. Free cash flow was approximately $2 million in the second quarter and was $39 million for the first half of the year.

Looking at our working capital. Accounts receivables decreased by $1 million during the quarter. Days sales outstanding was 58 days compared to 67 days in the prior quarter. Inventory remained flat at $245 million.

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 the 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. For fiscal year 2018, we continue to 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 to -- for your questions.

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

Anthony, are you on mute?

Apologies, I was on mute. Apologies for that. I'll begin with, maybe, Sunny, to circle back on China CT, a couple of questions there, and then a few questions on guidance and the R&D investment. So on China CT, Sunny, another -- a new order. It sounds like it's a new customer. So maybe just a recap on the -- how many customers within China you have on the CT side. And this newest order you announced today, is it similar to the prior orders in the sense that it's mostly CT tubes? So just the makeup of that order. And then, lastly, just -- is it a 3-year order, which was the case with the prior orders that you spoke about last quarter?

Yes. Sure, Anthony. As we discussed in the prior calls, we've been working with a whole slate of OEMs in China who want to be in the CT business and bring CT systems to market and there's -- as we've said, there's 10 to 12 of them. And so we have been systematically working with them and there's -- according to their development cycles, when they get to a point where they're ready to start their clinical trials and get ready to go to market, that's when we engage in the process of signing pricing agreements and multiyear purchase agreements with them. So this fifth one that we just -- that I just mentioned -- the one that I mentioned today was the fifth in the list of such customers. And there may be more that we're working with that which, over the years, hopefully, we will bring products to market and we will sign them up as well.

And in terms of...

Yes, the $50 million that I've mentioned is a multiyear -- is a 3-year agreement and it consists of actually several different products in there. And we didn't break it out into how much of that was CT versus detectors versus other products. But this was specific to China. We did about $50 million worth of new products, where we signed multiyear agreements in China.

Okay, that's helpful. And then just on the guidance, to touch on that a bit. So the top line's reiterated strong second quarter, a couple of questions. Maybe just on the top line, how many linear accelerator orders are still in the pipeline that you think can hit this year? And then maybe walk us through the R&D investments a bit. Obviously, taken up here a little bit and there is a multiyear investment on the R&D side. So is the R&D that you're announcing today, is that really geared toward final activity? Or is this sort of in a way we could look at as pipeline activity in the sense that you're already working on developing prototypes for customers.

So Anthony, this is Clarence. I'll answer the first one and then Sunny can probably give you a little more color on the R&D pipeline. Relative to the linear accelerator business, I guess, the first comment is that we did have a little bit of some orders shipped -- or some delivery shipped from Q1 to Q2 that most of that happened in the second quarter. And so, it was good to get that back on track. We don't give quantities -- specific numbers on quantities of linear accelerators that we're shipping by quarter. But -- and the challenge always in this business is it's got a little bit of lumpiness to it as such. And -- but the outlook that we have for the balance of the year is it looks good, it is picked up a little bit. I'd say we anticipate to see a moderate level of growth in that space now, not -- maybe low to mid-single digit kind of number, but it's somewhere in that kind of a range.

And then on the R&D, Sunny?

And on the R&D front, in a way, the last couple of years and this year are a bit unusual in that we had quite a bit of activity with a number of OEMs on the CT side. Now that's specific to China, but then our normal R&D pipeline of projects for other modalities for the other products like digital detectors, connect and control, those are in line with our normal, historical activity. So basically, in addition to our normal historical activity, we've got this bubble of projects that we're working on for some of the Chinese OEMs in CT. And those projects have gotten into a phase where we're beginning to ship a lot of prototypes. There's a lot of tubes that are being used for life testing and for other test purposes, so that's why there's an increase in R&D in our -- on the product development side and it's not typical. Now what normally would have happened is we would have restricted that amount of effort to our budget for the year and there would have been sort of a governor for that, and which there is. But typically, we do 2 things. We build these new products with our OEMs and we continue to sustain and fund longer-term projects, which are less product-oriented and more platform-oriented. So we might invest some money in developing new glass for some future detectors or some new types of faster performing application-specific chips. When we have -- when the product side of the R&D budget increases, typically we slow down the investments on the other side, on the foundational longer-term projects. But given the fact that we have a gain in -- with the reduced tax rate, we decided not to slow those down. So we're continuing on with our historical R&D work on products and continuing to support efforts in China. And at the same time, continuing to maintain the pace in our foundational technology work, which will help us in the future. So Anthony, that's sort of a little bit more color on why we're spending more money on R&D.

Our next question comes the line of Larry Solow of CJS securities.

Just a few follow-ups and then -- just on the revenue side, can you just give a little more color? You said CT sort of grew in line with the market on the detector side; at least on the medical side, they were down. So I'm just trying to get a ballpark of -- I guess, the CT was sort of mid-single -- low to mid-single digits on the upside. How about probably ballpark? And what about the detectors, specifically? They were down. Is that a function of just the continued realignment of scheduled deliveries from your customers?

Let me clarify that a little bit, particularly on the medical side, what I talked about was that detectors were in line with the plan. We had a bit of a decline in the radiographic detector space, but we had nice performance with oncology. We had the dental business return back to the normal levels or historical levels that it's been at after the Q1 where it was a little bit on the slow side. And then CT tubes did well compared to a year ago. When you're looking at just a single quarter, I'd say, then we actually had a nice uptick on the CT tube side, probably a little bit north of mid-single digits.

Okay. And they grew, I think, 10% in Q1, right, if I'm not mistaken. Or are they high singles? Is that right? I know at least on the Toshiba site (inaudible)

Let me -- I'll get back to you on that one because I don't know that one...

But they were up, I believe, in Q1, too, right. Even on the..

Exactly.

Right, okay. And just on the gross margin, just trying to -- obviously your guidance implies a nice improvement in the back half, more like -- up to the 39% number-ish. You've been sort of below the target range for a few quarters in a row. Is it -- it sounds like more of the same stuff. What gives you sort of the confidence that you can improve that? What steps have sort of been taken to improve it? And we'll call it out (inaudible)

Yes. I think you're spot on that the first half of the year, we're just a little bit north of 36% and we want to be in the 37.5%, 38% kind of range is what we'd like to be. But I think just because of that being half a year at the 36%, I now think that for the full year, it's 37.5%. So how does it get there in the second half of the year is the right question. First of all, I would put it into 3 categories. One is this product mix is always the interesting dynamic that we have in our business and with a little bit higher mix of CT tubes in the second half, that's a favorable thing for us as well. We have good visibility to the other mix of products that we've got in the final -- or actually orders in-house and identified, and those are a favorable mix for us, a little bit favorable mix for us there as well. The second element is volume. So higher volume, you get a little better overhead absorption and a little bit more productivity out of the factory. And so that's probably the other factor that helps us significantly here. And then the last is we've been monitoring very closely our cost of product failure, scrap, warranty, rework, those kinds of things, and it's actually an area where we've done a good job in the first half and we see more of that continuing in the second half. And so, the combination of those 3 is why we have confidence we can get there.

Okay. And I guess, the R&D, I guess, you're also assuming a little bit of a step down in the back half of the year...

Yes. More -- probably more of a factor because of the higher revenue. You keep the R&D similar level. But based on a higher revenue number, it'd help you get there. I would say that the timing of some of these prototype costs that Sunny was talking about for CT tubes is some of that is now kind of in our rearview mirror, and so I think that we got a chance to see a little bit lower R&D expense in the second half.

And you also support some accelerated development, but does that just mean push it? But is that throughout the year? Does it make the number higher? Or it is sort of within the year that's just rotating within the quarters?

I would say that's throughout the year and into next year.

Okay, so it was R&D net-net going to be little bit higher now you think than what you thought last quarter. For the full year?

Yes, for this -- for fiscal year '18, I've said it's going to be about 10%, and previously I've said [9.5%]...

Right, that's true. It's a little bit high. You guys said 9%. Okay, 9% to 10%. So now you're at the high end of that range, at least. Okay. [I knew it was off] the range, but I thought shift to the higher part of that range, at least.

Exactly.

Okay. And then, China, a nice new -- another attractive contract signed. So that, I guess, brings the total that you -- these 5 pending -- or 5 customers, $170 million over, whatever, 3 to 4 years. Is that right?

I'd be -- just careful there about mixing a little bit of apples and oranges because the agreements that we signed this quarter for China are multiple products, not just CT okay. So I think that's the -- what we've highlighted. So be a little bit cautious how you -- don't judge...

But they're doing incremental medical China OEM contracts.

Yes, exactly.

All on the medical side.

I noticed that there was -- I guess not -- any contribution you could speak of this quarter, modest, anything in the beginning stage. I know that you're supposed to have some this year, right, a little bit at least.

Yes. It's still very -- I would just say it is a back-end loaded year for the China activity. There's not -- I mean, we've been saying that for a while. I mean, and so nothing has changed there. So yes, a little bit of deliveries again and some of that is not necessarily even CT-specific. But we -- a good portion of what we sell in China today is not CT tubes, but also digital detectors and other diagnostic tubes.

Okay. And just the $4 million that should be in the other income, you said that was just some gains from some private investments. Is that...

Yes. So we have a few entities at our joint ventures that we have -- and so that's the -- first of all I'd say, other income has got several factors that go into it. One would be the impact of those joint ventures, the other is FX. So there's a little bit of impact there from revaluation of the balance sheet. That's pretty minimal. The -- but we have investment, and one of the larger ones is an entity named [Depix] that we -- that's all in our notes, the financials and the like. And they performed well, so we had favorable performance from them from both operationally and then also in terms of how they reduced some of their fixed costs. So I think that passes through to us kind of through the accounting process and it rolls down to other income, rather than up in the body of the P&L.

Right. So is that -- so that's actually -- it's not -- it's sort of the gain or loss in equity in the JV as opposed to a gain on the investment, right?

Yes, exactly, because we're not -- we don't have a -- we don't consolidate them. We don't have a controlling interest that way.

Got it. So -- but it was a pretty big swing this quarter, right, because I haven't even -- I haven't seen much. I know the [Depix] JV, but I haven't seen it move much. I was just sort of curious maybe since you're not putting -- making EPS non-GAAP, maybe that shouldn't be in there. I don't know, it's sort of a...

No, no. This is operational performance by them. So this is not a non-GAAP type of item.

No, I get it, I get it. It's just a little lumpy, I guess. But okay, that's fine. Just lastly on the Perkin. You spoke about integration, the cost cut in to $5 million. You're on target. The revenue synergy is obviously a much longer-term horizon there, but it's sort of a multiyear process. Can you just qualitatively talk about how you see opportunities advancing? I imagine you've been talking to other customers now that you've had them for over a year and you're still confident in some of your -- and this year, it's on the revenue synergy side. Not this year, but over the next whatever, that 2 to 3 years.

Yes. So we had said that we expect to see $15 million to $20 million in cost savings by year 4; and then on the revenues side, we had said $20 million to $30 million revenues by year 4. Obviously the costs are -- you start working on it on day 1 and start realizing those, which we've been doing. So $5 million was what we had targeted for this year and that's squarely on track. On the revenue side, we did a lot of work to consolidate the product line, to get the sales team consolidated. All that is going well. And so at this point, we haven't seen any material. We haven't expected it. Would it be year 1 there'd be much in the revenue synergies? But we're still -- we feel bullish about hitting our goal of $20 million to $30 million revenues by year 4 as the run rate. So we're on track for that. There's the customer activity that's there. And the new products that we're introducing give us that confidence.

Our next question comes from the line of Francesco Faiella of Sidoti & Company.

I kind of have a higher-level question on your -- maybe, your M&A strategy. I know the focus right now maybe looks like to pay down some debt. But I was wondering if you look at acquisition, is that something that can maybe widen the product portfolio or maybe get you some vertical integration or how you kind of look at those opportunities?

Yes. Francesco, this is Sunny. We have been active with M&A for the past several years. Even when we were part of Varian, we've acquired companies. The PerkinElmer acquisition is now lapping its 1-year anniversary and we've done a good job of integration. We intend to continue to be active in this space and we continuously evaluate M&A opportunities. And what we've said is that our priority is to look for consolidation. There's parts of our business where consolidation is -- has -- there's some potential, and like the PerkinElmer acquisition was one of them. And then the second thread of our M&A is looking at new product lines that we can add to our portfolio. And I'll summarize by saying, look, we're constantly, actively participating and screening the companies that we know, looking for these kinds of opportunities and we will continue to do that. And at this point, with our good strong cash flows, we're paying down the debt. When we have an opportunity to do some M&A, we'll apply that cash towards that. Clarence would like us to get down to having 3x -- lower than 3x, maybe 2, 2.5x.

We're 3x now, so we'll get down to 2.5x. But...

But we won't put M&A. If there's a good deal to be done, we'll do it and we'll fund it.

Sounds good. I Appreciate that. And then I just had another quick one. I know it's not your strategy, but I was wondering if there's anything ongoing in terms of outsourced manufacturing for -- that you guys do for some of the OEMs. Or is that totally off the table at this point?

No. So we're not an outsourced manufacturer in terms of our core business. We develop and design products that -- then we manufacture for the OEMs. So essentially, we -- the IP is ours. It's our product, it's our design and we then manufacture it. Historically, we had one deal where we were a contract manufacturer. It was just, I'd say, a situational thing, but that is not our core model. Our model is it's our IP and we get reengineered in and then that's how we stay engineered in for a long period of time.

(Operator Instructions) We have a follow-up question from the line of Anthony Petrone of Jefferies.

Just a quick follow-up on maybe just the top line in terms of the outlook and sort of the lumpiness. Is the company looking at any alternative contracting models with OEMs where perhaps the visibility can be improved? Because it sounds like, in the past, it tends to be whether it's back-end loaded, purchasing from OEMs or just sort of reactive supply to the OEM's needs, which kind of leads to some of the lumpiness. So is there an attempt to sort of smooth that out? And if so, how long do you think that will take? And then I'll have just one follow-up.

Okay, Anthony, this is Sunny. I will take a crack and then maybe Clarence can chime in. So our lumpiness is in 2 areas. First of all, in the security business where it's tender-driven, there's this natural lumpiness without a cycle that we can forecast too well. But that said, we get visibility to deals and tenders that are out there and the lumpiness is around the timing of the tenders and when the shipment is going to occur. There, we don't have much by way of a choice of trying to figure out how to smooth that out. But what we've been doing in the security segment is we've been very active in selling our ongoing services. So that's -- the revenues in the security business comes from shipment of [Linux] and our products, as well as from maintenance contracts and services. And the bigger that services' base skips, the more I'd say the revenue starts to smooth out. And that's the approach we are taking. On our other products, the tubes and detectors, the lumpiness is usually the -- is short term. It's from month-to-month, quarter-to-quarter. But within the year, we've got fairly good line of sight to what each of our customers are going to take. We have -- we do continuously work with our customers to try to smooth out and flatten out this lumpiness. We try to get them to give us a level-loaded forecast and take products in a level-loaded way, and that's the path we're taking. Now we've also told our customers and put it out there for them saying, "Look, if you do change your business model to any other type of per whatever, per unit of measure, if you pick that kind of a model and you go down that path, we would be willing to work with them back to back to back, support them on that type of a model." Unfortunately, we don't sell directly to the hospitals. We're kind of reliant on our OEMs to take the lead and that market hasn't gone there. This is still a capital equipment market and people buy based on their budgets. But we're open to that, and if our OEMs want to go there, we will absolutely go there with them. I mean, by the way, we do continue to push them to see if they're willing to look at a different business model.

No, it's helpful. And then maybe just the last one real quick would be on sort of your top 5, top 10 customers. Obviously, Toshiba is in there. I think the renewed Toshiba contract is still relatively young, but is there anything sort of large in there that is coming up for renewal in the next year or so?

So first of all, we're now calling them Canon because they went through a name change. And -- so we keep correcting ourselves as we do this. But yes, the Canon agreement was done a little over a year ago, and so I think that's -- and it was a 3-year agreement. The other -- the next largest customer is GE, and I believe that agreement is still got a little -- another couple of years or so to go on. And so, I mean, it's not one of those as well that is going to be up for immediate renewal. Beyond that, I'm not aware of any large customer that would be immediately up for renewal.

Our next question comes from the line of Robert Hellauer of Casey Capital.

My first question is a follow-up on China. Forgive me if I misunderstood, but it sounded like you said you signed the contracts when you have -- they have a prototype and it goes into trial. So can you kind of give a time line in terms of the length it takes to go from trial to full commercialization within China?

Yes, this is Sunny. So let me address that. Our customer -- when we sign purchase agreements or pricing agreements with our customers, we typically ask them for volume forecast. So they've got to give us what they're going to do, what their projections are for year 1, year 2, year 3. And based on that, our pricing is typically tied to volumes and we base our business plan on that. So there's usually -- before the project, they have some kind of a business plan. And then as they get closer to completion of the project, they refine their projections and then we give them pricing based on that. So that's why if it takes 3 to 5 years to -- I look at 3 years to bring a product to market, it's usually in the third year when they apply for registrations and their internal CFDA approvals. That's when typically the conversation moves towards, "Okay, let's sign a contract. Let's sign a supply agreement," because those approvals can come in any time and we have to start ramping up the supply chain. It takes about a year for most of our customers to get their registrations in China. FDA approvals might be faster, but the process generally takes about a year and then they typically launch their products. So that's why for some of the contracts that we signed in latter part of last year, we said we expect to start seeing revenues coming out towards the second half of this year. That was an anticipation that they would get their registration sometime around this time frame or next quarter or the quarter after and we would start to see the traction. So the customers that are filing for registration now and are signing for pricing agreements with us, we will see revenues from them next year. So it's usually about a 12 month-ish type of a time frame.

Great, that's very helpful. And in terms of just quick follow-up in China, do you have any sense in terms of how much, as you ship it into China, how much is incremental to the market versus potentially maybe your new Chinese customers going in and taking market share from another western OEM that you might supply already.

Yes. So I think, at this time, the Chinese market is like a typical emerging market where a majority of the volume is net new. So that said, internally, with -- so China's CT -- deployment of CT is growing, the market is growing, and the Chinese people that are in that market are all going after all the net new sales. That said, there's also market share movement between them, between the global players and the local players. But it is net new volume. I mean, the number of CTs sold this year was, in 2017, is going to be higher than last year and then the year before and the year before. So there's a sequential growth in the sales in China and we haven't seen -- we were not anticipating a plateau of that in the next few years.

Perfect. And just a few quick modeling questions. I noticed that the restructuring cost for the quarter went up sequentially from about $400,000 to $2 million. I know in the last call, you've highlighted you're trying to invest in R&D and SG&A for future growth spikes such as some of the things that you mentioned. How come -- I'm just trying to bridge the gap between investing in R&D and the restructuring cost. Can you give a little more detail around that?

Sure. So no surprise that, as you do an acquisition, you look at your global footprint and you look at where you want to be located, where you want activities to be done. And so we made a choice to do a little bit of consolidation. And that's the majority of that restructuring charge. So I called it integration and restructuring. So there's a combination of ongoing integration costs, which is like IT systems and the like, that type of work, but there's also this quarter a restructuring charge as well.

Okay. And then just my last question is on organic revenue. If I look back at your prior year -- fiscal year Q3 last year, I think that was the first quarter with PerkinElmer, organic revenue might have been slightly down on a year-over-year basis from your fiscal year 2016. So when I think about fiscal year -- next quarter, what your guidance imply, how should I think about what the 2-year comp stock is in terms of organic revenue?

Yes, I'll take a shot at that. I want to clarify, first of all, that because the acquisition closed at the beginning of May, our Q3 of a year ago only had 2 months of the PerkinElmer business or the acquired imaging business in our numbers. So -- and it was, I think, $27 million. And so it's a little bit of -- you got to be careful about apples and oranges there when you're doing a comparison. The -- and then, maybe the other point of reference, which I mentioned in the prepared remarks, was that Q2 of last year for them, prior to us being acquiring them, they had $36 million of revenue. I believe that their Q3 was something of a similar size. So that's ultimately what we'll be comparing with. I don't know if that fully answered the question, but I can give you a little bit more color on the historical numbers, I guess.

Our next question comes from the -- our next follow-up question comes the line of Larry Solow of CJS Securities.

Great. Just to follow up on Rob's question there. Obviously, it's a very back-end loaded year. How should we think of sort of the cadence in Q3 and Q4? That sounds like the gross margin on the cost side a little bit. At least as percent of revenues, they're going to come down for the whole half. But is it going to be even more backloaded and loaded towards Q4 similar to how last year was? Just trying to help avoid any unnecessary surprises because I think -- remember last year there was sort of a big drop in Q3, which seemed like you guys were sort of expecting, and then as it turned out, Q4 rebounded. So how should we view that? And then, I guess, similar to the comp at least obviously year-over-year is much easier in Q3 on a relative basis.

Yes, I'll -- without giving specific numbers out of my forecast right now, I'll tell you just how -- I would say that Q4 is going to be larger than Q3. I mean -- and I say that Q3 is going to be -- it's not going to be a surprise low quarter. I mean, I would -- maybe that's the way to put it because it's not -- we had a good quarter this quarter and it would be -- Q3 would be something comparable to that or somewhere a little bit north of that.

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 closing remarks.

Thank you for your questions and for participating in our earnings conference call for the second quarter of fiscal year 2018. A replay of this conference will be available from May 3 through May 17 and can be accessed at our website or by calling 1 (877) 660-6853 from anywhere in the United States or 1 (201) 612-7415 from non-U.S. locations. A passcode is required and that number is 13678618. Thank you very much, and goodbye.

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