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Varex Imaging (VREX) Q4 2021 Earnings Call Transcript

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VREX earnings call for the period ending September 30, 2021.

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Varex Imaging (VREX -12.47%)
Q4 2021 Earnings Call
Nov 16, 2021, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Greetings. Welcome to the Varex fourth quarter 2021 earnings conference call. [Operator instructions] A question-and-answer session will follow the formal presentation. [Operator instructions] Please note, this conference is being recorded.

I will now turn the conference over to your host, Chris Belfiore, director of investor relations. You may begin.

Chris Belfiore -- Director of Investor Relations

Good afternoon, and welcome to Varex Imaging Corporation's earnings conference call for the fourth quarter of fiscal year 2021. With me today are Sunny Sanyal, our president and CEO; and Sam Maheshwari, our CFO. Please note that the live webcast of this conference call includes the supplemental slide presentation that can be accessed on our -- on Varex's website at investors.vareximaging.com. The webcast and supplemental slide presentation will be archived on Varex's website.

To simplify our discussion, unless otherwise stated, all references to the quarter are for the fourth quarter of fiscal year 2021. In addition, unless otherwise stated, quarterly comparisons are made sequentially from the fourth quarter of fiscal year 2021 to the third quarter of fiscal year 2021 rather than the same quarter of the prior year. Finally, all references to the year are to the fiscal year and not calendar year, unless otherwise stated. Please be advised that during this call, we will be making forward-looking statements, which are predictions and projections about future events.

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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 in our filings with the SEC. Additional information concerning factors that could cause actual results to materially differ from those anticipated is contained in the -- our SEC filings, including Item 1A, risk factors, of our quarterly reports on Form 10-Q and our annual report on Form 10-K. The information in this discussion speaks as of today's date, and we assume no obligation to update or revise the forward-looking statements in this discussion.

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

Sunny Sanyal -- President and Chief Executive Officer

Thank you, Chris, and good afternoon, everyone. Fiscal 2021 was an outstanding year for Varex despite what turned out to be a very challenging and dynamic environment. As we entered the year, uncertainty around the ongoing effects of COVID were top of mind. Pent-up demand and an increase in focus by many countries around the world on expanding their healthcare delivery capabilities has increased the demand for diagnostic imaging systems.

As the year progressed, this increased demand was met with supply chain constraints that challenged both our output levels and our profitability. That said, we continue to execute on our strategic initiatives, improving gross margin, reducing operating expenses and inventory, and introducing new products and technology to drive future growth and profitability. Turning to the fourth quarter, I'm excited to report a strong finish to the year. Broad-based strength globally, especially in our medical segment, drove record quarterly revenues of $226 million in the fourth quarter.

Profitability improved in the quarter driven by strong growth and stable operating expenses. Improved earnings and working capital management helped drive robust cash generation. Cash flow from operations was $51 million in the quarter and the cash balance at the end of the year was $145 million. Global demand for CT tubes remains strong in the quarter, as did the demand for detectors in both medical and industrial applications.

While the third quarter marked a return to pre-COVID levels or better for many medical modalities, I'm pleased to say that the fourth quarter saw all modalities above pre-COVID levels. Our revenues in the fourth quarter increased 7% sequentially and 33% year over year, with both medical and industrial segments showing strong growth. Non-GAAP gross margins in the quarter were 34%, as strong volumes were partially offset by supply chain challenges. Non-GAAP operating margin was 14% of revenues, and non-GAAP EPS of $0.45 exceeded the top end of our guidance range.

Let me give you some high-level insight into how our different modalities and applications trended during the quarter. Medical segment revenues increased 8% sequentially and 33% year over year. We continued to see [Audio gap] globally for CT tubes in the fourth quarter. In our other medical modalities, oncology, radiographic, dental, and mammography posted sequential growth and were above pre-COVID levels.

Fluoro was somewhat flat in the quarter due to timing of shipments. Revenues in our industrial segment increased 4% sequentially and 34% year over year. During the quarter, demand for digital detectors for nondestructive inspection remains strong in several of our industrial verticals, including battery inspection and oil and gas. Demand for imaging products for security screening at ports and borders, as well as baggage screening at airports, continued to be soft, but both remain headed in a more positive direction.

As we have done in the past, I would like to highlight the outstanding work we're doing in one of our businesses. At Varex, our mission is to make the invisible visible, and our AI-aided software is strategic to that mission. This software will be on display at RSNA in a few weeks, along with other products such as photon-counting detectors, nanotubes, lead platform detectors, and our new LUMEN detectors. Our software business represented over $30 million in revenue in fiscal year 2021.

As imaging becomes more accessible globally and efficient workflow becomes more critical, we're excited about the growth potential that AI-aided software represents where, actually, AI-aided software leverages our more than a decade of field-based experience with software for image analysis and computer-aided detection that is installed on thousands of diagnostic workstations globally. We have been able to apply these competencies for developing AI-aided software for breast, lung, neuro, and liver imaging, and we expect to continue this development across various other imaging modalities. With an increasing focus on connectivity and integration, we're happy to be able to offer this software via the cloud. Our AI-aided lung screening software called Veolity is setting new standards in the industry as a trusted diagnostic platform for high throughput environments.

With an increased focus on lung screening globally, we think Veolity has the potential to become a significant contributor to our software growth. We have been participating in tenders globally. And recently, we won a tender to provide lunch screening software for nine hospitals in the province of British Columbia in Canada. We expect this win and other projects won in Europe and the United Kingdom to help drive broader adoption of Veolity over time.

In the U.S. alone, there are over 200,000 lung cancer cases and over 60,000 deaths from lung cancer each year. A high mortality rate of about 19% is mainly [Audio gap] late diagnosis of lung cancer, catching the disease at a point where it's often too late to treat effectively. However, over the last few years, global and national recommendations have encouraged early lung cancer screening using low-dose CT among more high-risk groups.

In the U.S., this could potentially increase the number of persons eligible for screening from about 6 million to nearly 15 million. With other regions like Europe, Canada, and Asia following suit, we expect this expansion of lung cancer screening to continue to grow. This expansion will require productivity-enhancing software that supports effective high-volume screening. This is a key capability and a strength of Veolity.

Our Veolity AI-aided software can enhance radiologists' productivity by enabling them to perform CT lung screening quickly and with AI oversight for added diagnostic confidence. This software offers automated workflow with historical comparisons and 3D volume measurement capabilities that tracks the progress of a tumor over time and can help with early detection of cancer. Over the last five years, Varex has licensed over 570 instances of Veolity across the Americas, Europe, and Asia. Global lung cancer screening market is expected to grow at 20% CAGR from a base of approximately $20 million in calendar 2021, and we expect to benefit from this market growth.

We are excited about the possibilities that AI-aided software can bring to the imaging world and proud that Varex is an innovator in this space. As we expand our AI-aided software capabilities into other applications, we expect this business to become a larger contributor to Varex in the future. Before I hand over the call to Sam, I'd like to take a minute to reflect on the past year. As noted earlier, fiscal 2021 was a record year for Varex across the board.

[Audio gap] demand drove our business to new levels. Looking back to a strong period before COVID, revenue was up 5% from fiscal 2019 to $818 million in 2021, while adjusted EBITDA was up 15% to $133 million. This translates to nearly 50% incremental margin, an outstanding accomplishment from a [Audio gap] to be very strong at a time. This increase includes the results from the first quarter of fiscal 2021, which was still significantly impacted by the effects of COVID.

As we all know, the strong results exiting fiscal '19 were met with significant headwinds from COVID, but the actions that we took to bolster our financial position helped us recover to an even stronger position. Robust demand drove revenue growth of over 30% from the low point in the fourth quarter of 2020 to $226 million in the fourth quarter of 2021, while adjusted EBITDA grew 10x to $40 million. This strong sequential quarterly improvement culminated in record revenue of $818 million in fiscal 2021. This revenue, along with continued expense management, led to gross margins of 34.7% in fiscal 2021, while adjusted EBITDA improved to $133 million and EPS finished the year at $1.31.

During this period, global CT volumes increased double digits. In fiscal 2021, we generated record operating cash flow of $93 million, and our cash balance ended the year at $145 million even after paying down $30 million of our debt in July. I'd like to take a moment to recognize all our employees, customers, and suppliers globally for continuing to weather a very difficult environment and meeting elevated demand levels through significant supply chain challenges. Fiscal 2021 set a strong foundation for us to build upon.

As we move into 2022, demand remains strong, the supply [Audio gap] and we're confident in our ability to deliver quality products to our customers. While we expect COVID and supply chain issues to remain part of our business environment during fiscal 2022, we are steadfastly maintaining our focus on Varex 2.0 and the long term. The focus of that journey is centered around expanding our leadership position through innovation and continued focus on improving profitability. Our fiscal 2022 expenses include fully funding several R&D initiatives that we will expect to drive future growth.

As we have discussed earlier, we're developing several exciting new products such as photon-counting detector for CT, a family of next-generation radiographic detectors on flexible substrate, several advanced tube models for CT, and cardiovascular applications. AI-aided software and new connecting control components as well. We expect to have customer prototypes of CT photon-counting detector modules available in the second quarter of our fiscal 2022. We expect that these and other innovation initiatives will expand our addressable markets and increase our position as a preferred partner for innovative technology with current and potential customers.

While our Local for Local platform in China continues to be highly successful in CT, we are now engaged with local OEMs on our innovation in x-ray tubes, detectors for applications such as cardiovascular, oncology, and surgery. Our joint venture, VEC, is making steady progress with nanotube technologies, and we are at a stage in our development process where we are shipping prototypes to industrial OEMs. Our continued focus on improving profitability and cash generation are driven by investments in our factory, ongoing improvements in productivity and yield, and reducing product costs through lower-cost designs, vertical integration, and supply chain actions. We have weathered the uncertainties created by COVID so far and have come out stronger.

In the same way, we expect to continue to navigate the current supply uncertainties and emerge with a more resilient supply chain globally. With that, let me hand over the call to Sam.

Sam Maheshwari -- Chief Financial Officer

Thanks, Sunny, and hello, everyone. As a reminder, unless otherwise indicated, I will provide sequential comparison of our results for the fourth quarter of fiscal year 2021 with those of our third quarter of fiscal year 2021. Varex continued to deliver strong results in the quarter, with solid demand across all modalities. Revenue and non-GAAP EPS were higher than our guided range.

Fourth quarter revenue was $226 million, an increase of 7% from the third quarter. Medical revenues were $181 million, and industrial revenues were $46 million. For both Varex in total and the medical segment, this is the highest quarterly revenue level we have posted. These revenue levels translated to 80% medical and 20% industrial sales.

Sequentially, medical sales grew 8% and industrial sales grew 4%. Revenue levels in all three regions remain strong in the quarter. EMEA declined 2% sequentially, America grew 7%, and APAC grew 18%. China revenue was $112 million in fiscal year 2021.

Let me now call our results on a GAAP basis. Fourth quarter gross margin was 33%, down 200 basis points from the previous quarter. Operating income of $27 million was $1 million higher than the third quarter. Net earnings declined $9 million compared to the previous quarter, primarily on a higher tax provision of $6 million, compared to $3 million in the prior quarter.

Earnings per diluted share were $0.20, compared to $0.29 in the third quarter. Moving on to non-GAAP results for the quarter. Gross margin was 34%, down 200 basis points from the third quarter and higher volumes were partially offset by ongoing supply chain challenges. At the beginning of fiscal 2021, we aimed to expand gross margins through cost reduction initiatives, as well as improved efficiencies in our manufacturing and [Audio gap].

As noted earlier, in 2021, we grew our gross margins 470 basis points to 34.7% for the full year. We are very pleased with the gross margin improvement we saw in 2021 and believe it sets a solid foundation for 2022 and beyond. As we have noted in the past, we continue to expect gross margins to be 35%, plus or minus 100 basis points. Despite the robust demand environment during the quarter, supply chain and freight expenses impacted gross margin more than originally anticipated.

Freight impacted gross margin by about 30 basis points sequentially. In addition, during the quarter, we qualified various alternate suppliers, and as a result, resources were diverted toward solving supply chain issues. For this reason, approximately $1 million of R&D was charged to cost of goods sold as compared to the third quarter of fiscal 2021. This impacted gross margin sequentially by about 50 basis points.

As we have highlighted since the second quarter, supply chain constraints largely around [Audio gap] and logistics has been a persistent headwind. These challenges became more pronounced in the fourth quarter and impacted the availability and cost of some materials used to make our products, especially semiconductors. We continue to work through these challenges with current and alternate suppliers to mitigate impact, but this has been and continues to be a dynamic environment. In the backdrop of such a rising input cost environment, we are working to mitigate the impact of increasing cost through expense management and price increases.

In late October, we rolled out a broad-based price increase of mid-single-digit percentage or higher. Since many customers are on annual price contracts, we expect pricing adjustments to kick in gradually throughout fiscal 2022. R&D spending in the fourth quarter was $18 million, or 8% of revenue, within our 8% to 10% target range. Recall that R&D was lowered by $1 million as it was redirected to cost of goods sold.

SG&A was approximately $27 million in Q4, roughly in line with the prior quarter. Operating expenses were $45 million, down $1 million from the prior quarter as explained above. Lower operating expenses helped drive an 8% increase in operating earnings from the previous quarter to $33 million. Despite [Audio gap] margin, our operating margin held steady at 14% of revenue.

Tax expense in the fourth quarter was $6 million, similar to the previous quarter. Net earnings increased to $19 million, or $0.45 per diluted share, compared to $16 million, or $0.40 per diluted share, in Q3. Average diluted shares in the quarter were 41 million, compared to 39.8 million in the prior quarter. Please note that due to our convertible notes related bond hedge and associated trading range of our shares, there is a difference between diluted shares for GAAP and non-GAAP purposes.

GAAP share count ignores the bond hedge, while non-GAAP share count includes the economic benefit from the hedge. We have provided a reconciliation between the two at the end of our earnings press release. The appendix offers a slide to provide the table showing the effect of the convertible notes related bond hedge on the diluted share count for GAAP and non-GAAP purposes. Now, turning to the balance sheet.

Accounts receivables increased by $7 million, mainly due to high sales in the quarter. DSO improved by two days to 62 days. Inventory declined $18 million and days of inventory improved to 136 days. Accounts payable decreased by $7 million and days payable was 36 days.

Now, moving on to debt and cash flow information. Cash operations improved to a record $51 million, driven by improved profitability and working capital. We ended the quarter with cash of $145 million on the balance sheet, an increase of $17 million in the quarter after paying down $30 million of debt. Gross debt outstanding at the end of the fourth quarter was $481 million, and debt net of cash declined to $336 million, reflecting our priority to continue to de-lever on a net debt basis.

Adjusted EBITDA was $40 million in the fourth quarter, up $1 million from the prior quarter. Adjusted EBITDA margin was 18% in the quarter. A combination of improved profitability and our robust cash generation has helped lower our net debt leverage ratio to 2.5 times at fiscal year-end. Recall, our goal was to bring our net debt leverage ratio below three times.

Fiscal 2021 presented challenges seemingly at every turn, from higher than anticipated demand levels to a severely constrained supply chain. But we remained focused on our strategy to improve both capital leverage and operating leverage. To that end, I would like to thank our Varex colleagues worldwide for their tremendous efforts in staying on course and achieving these excellent results. Before providing guidance, I wanted to take a step back and discuss our revenue results for Q4 in the context of our expectations for Q1.

Our Q4 results came in higher than expected in part because, toward the end of Q4, we received some raw material earlier than planned, and consequently, we're able to meet additional customer demand. The supply chain environment remains significantly unpredictable and lumpy. While Q1 demand remains strong and higher than Q4, due to supply chain constraints, we may not be able to ship all the demand in Q1 and have taken this into account when establishing our guidance. With that as a backdrop, here is our guidance for Q1.

Revenues are expected between $200 million and $220 million, and non-GAAP earnings per diluted share are expected between $0.20 and $0.40. Our expectations are based on the following. Non-GAAP gross margin in the range of 34% to 35%. Please note, going forward, we expect gross margin to be an ongoing and a dynamic balance between price increases and rising costs.

Non-GAAP operating expenses in the range of $45 million to $46 million. Tax rate of about 23% for full fiscal year 2022. Non-GAAP diluted share count of about 41 million shares for Q1. And a slightly higher capex of about $25 million for full fiscal 2022 to expand capacity for our tubes factory, as well as complete the buildout of our new cable factory in the Philippines.

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

Questions & Answers:


Operator

At this time, we will be conducting a question-and-answer session. [Operator instructions] Our first question is from Anthony Petrone with Jefferies. Please proceed with your question.

Frank Pinal -- Jefferies -- Analyst

Hi, guys. This is Frank Pinal on for Anthony. I guess, first, congratulations on a very nice quarter again. The first question I guess, we -- we're seeing a lot of companies touching on supply chain impacts, and you sort of touch on it with delay and pricing increases.

Just sort of wondering what you're seeing as you were exiting the quarter and a higher sort of thinking about 4Q, maybe if you can touch on, you know, China, maybe port congestion that's impacting you? And perhaps, how long do you expect these impacts to persist? Are these going to mid-2022, to the back half, or beyond? Thank you. 

Sunny Sanyal -- President and Chief Executive Officer

Hi, this is Sunny. I'll hold touch on -- I'll open it up. It's a pretty broad question, and I'll let Sam jump in and give the financial implications. You know, the port congestions for us that is -- was a problem at a point in time, but we've moved away from ocean freight to airfreight for all our inbound.

So, from a freight perspective, you know, the outbound costs of freight, those are handled by our customers who picked up from our doorstep. The inbound that we buy from -- our input materials that we buy, those come through airfreight. So, we've been able to avoid the delays and congestions at seaports. Our supply chain issues continue to hover around the fact that material supply from our suppliers have become very lumpy.

You know, they're unpredictable. They're lumpy. Now, this is not new. It's been going on for a good solid 12-plus months now, and we're just managing through it.

And it's becoming difficult because more and more of these suppliers are falling behind, but we're just managing through it. And increasingly, as Sam pointed out, we've been qualifying alternate suppliers. This has been an ongoing dynamic situation, qualifying alternate suppliers and figuring out how to fill in the gaps, and that is continuing.

Sam Maheshwari -- Chief Financial Officer

Yeah. And I -- Frank, I think -- this is Sam here. Thanks. What I can add here is, you know, more and more, for instead of ocean freight, we are going airfreight, and that is much more expensive.

So, you know, sequentially, we were 30 basis points higher on freight. But as I look at our long-run average, freight is running 60 basis points higher. So, it is expensive. And as Sunny said, things remain lumpy and unpredictable.

Sometimes, stuff comes in a bit sooner. And sometimes, at the last moment, we would be told that it's going to be a week late or two weeks late or three weeks late, and that causes a lot of inefficiencies in terms of factory scheduling and providing or shipping the product on time. So, all those issues are going through, and we're managing through it. But we are actively managing through it, but it is definitely a drain on the performance.

Frank Pinal -- Jefferies -- Analyst

Great. Thank you for that. I guess the next question if you will. If you could touch on underlying demand [Audio gap] CT, also backlog, that would be great.

And I have one follow-up question after that.

Sunny Sanyal -- President and Chief Executive Officer

The demand for CT in China is continuing. I mean, it's been the one thing that's been steady and increasing, and it's driven by, as you know, continued expansion of healthcare services in China, and the Chinese government has not let up on that. Secondly, our participation there is pretty strong because of our -- because we've got several Chinese OEMs, eight Chinese OEMs that are designing in our products that are -- that started the journey a while ago, and they're continuing to release more systems. So, that continues to remain strong.

The demand there is strong. And into the foreseeable future as well, we see this continuing.

Sam Maheshwari -- Chief Financial Officer

Yeah, and, Frank, to your question on backlog, I can add that, typically, we have not provided backlog number every quarter, but it is in our 10-Q or 10-K documents. We are planning to file our 10-K in a week or so here. We've been working on it. So, backlog did increase [Audio gap] Q4 significantly from Q3.

But I just want to remind you that backlog is not necessarily a very strong [Audio gap] for our revenue performance. Nonetheless, backlog was significantly ahead of $300 million, and to slow the [Inaudible] into $20 million -- $327 million were not at the end of Q4, which is around 250, 260 previously. But again, I want to caution you. Backlog is not necessarily a predictor of future revenues for us because things can change.

Frank Pinal -- Jefferies -- Analyst

Great. Thank you for that, Sunny and Sam. Just one last one here. I'm just wondering if you can provide any sort of color or updates on nanotech x-ray technology.

I think most people are generally excited to hear about that.

Sunny Sanyal -- President and Chief Executive Officer

Yeah. You know, it's a novel technology. And as you know, Frank, in our business, it takes time for introducing novel technologies. And then also, since we go through a B2B OEM channels, you know, we've -- when we -- after we have the technology, then we feel it's ready for our customer consumption and our customers start the consultative process, so trying to understand what to do with this technology and how they start conceiving of applications.

But we're -- I'll summarize by saying that we're -- we also continue to be excited about this technology. We have been steadily and continuously validating the technology itself and assessing the parameters for this technology -- the performance parameters and characteristics so that we can have intelligent consultative conversations with our customers about what kinds of applications it would be suitable for. So, we're at that stage now where I mentioned that we are -- we're now including in our customers into our -- into that piece of the work, and we are shipping prototypes to prospects, you know, who want to validate this technology. So, that's where we are.

Frank Pinal -- Jefferies -- Analyst

Great. Thank you so much. Congrats on a great quarter again.

Sunny Sanyal -- President and Chief Executive Officer

Thank you.

Operator

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

Larry Solow -- CJS Securities -- Analyst

Hey, good afternoon. Thanks for taking the questions. I guess, just the first question, just sort of a general question. It sounds like demand is pretty strong across some -- both segments and most modalities.

Other than fluoroscopy, is there anything that's sort of been a laggard? And you did mention, I know, industrial side, the cargo is a little bit, you know -- has been a little bit slower, but that's sort of improving. Anything else that's, you know, sort of hasn't, you know, maybe has come back in COVID, but it's sort of languishing? And maybe a little more insight on the industrial side. I know -- you know, you said NDT is doing well, any other things that are doing well there?

Sunny Sanyal -- President and Chief Executive Officer

So, as we've said, all modalities did well in the fourth quarter. And the fluoro -- you know, fluoro, that's timing, as you know, in our business. Sometimes, one quarter I might find one modality is slightly down, next quarter someone else is slightly down. So, there's no pattern there.

And in the -- a couple of the modality -- so CT has been strong throughout, as you know. Surgery has held the ground throughout. Cardiovascular, after the initial slowdowns during COVID, you know, is starting to come back up as procedure volumes came back up. And then mammography was slightly slow at coming back up, but now, we're seeing strength there as well, and it's returning to good health so to say.

So, you know, Larry, there's nothing that's -- that I can call out and say in the medical side that hasn't recovered or hasn't shown some strength. Even dental, as you know, is -- there was some -- we had a hard time identifying patterns because you would move around the globe in different patterns, depending on as COVID moved around. But even within dental, we're [Audio gap] you know, in that recovery and growth type of mode. On the industrial side, cargo and security, in general, cargo and airport security, although they're on the right trajectory.

And, you know, as you look at our customers, major OEMs in that space, they're also reporting orders, confirming orders that they've received. And sooner or later, we expect those to translate into shipments for us as well. So, that is a positive sign. And as we said, that's moving in the right direction.

Industrial NDT, you know, it's areas that were strong previously that we mentioned in our earlier calls like electronics inspection, battery inspection. Our detectors are doing very well in that space. And then broad-based NDT is -- seems like business as usual.

Larry Solow -- CJS Securities -- Analyst

OK. No, that's a very good color there. And just a question just on guidance. I know you're no longer giving annual guidance, just going to give the quarterly guidance.

Sort of a bunch of moving parts, maybe you can just help better frame the year. I don't know if there's any seasonality or if that even comes into play anymore. Q1 used to be slower, but maybe with supply chain stuff and still, you know, COVID made that skewed a little bit. But it sounds like you have a couple of pluses going forward.

Pricing will roll in, and you'll get more of a benefit as the year goes on. Let's call seasonality a washer now. Supply chain, did this -- did you expect that to get better or worse, so you -- should you make up or expect to make up this lost revenue? And, you know, I guess it sounds like R&D might be a little bit higher. So, just trying to -- you know, this Q1, is that a good representation of the year, or should we expect things to get better, get worse, you know, marketable on either side of that? Maybe you can just help give us a little more, you know, perspective from a high level.

Thanks.

Sam Maheshwari -- Chief Financial Officer

Thank you, Larry. Yeah. That's a lot of question there and a lot of [Inaudible] a lot of good ones, Larry. So, yes, absolutely.

So, yes, you're right that, in general, Q1 is a slow quarter for us, but that is when the world is in a demand-constrained environment as you know.

Larry Solow -- CJS Securities -- Analyst

Right.

Sam Maheshwari -- Chief Financial Officer

Then, in a normal year, there is seasonality because of demand and all of that type of stuff. So, that concept applied there. But right now, as we indicated quite clearly, that we are operating in a supply constrained environment, so seasonality goes out of the window. And essentially, if the supply chain bottlenecks were not there, then we would be shipping more than what we are guiding here.

But we are clearly operating in that constrained environment. So, I would say that not to focus too much on seasonality but maybe perhaps by the following year, in 2023, seasonality comes back and all of the supply chain constraints are removed. Who knows? So, that's the perspective on seasonality. Then in terms of the year as it develops, etc., the way we are thinking about the situation is that -- how we are planning? You know, we are planning to invest in R&D resources.

We are planning to invest additional capex in increasing the capacity for the tubes factory and a number of other things. So, we are expecting FY 2022, our fiscal '22, to be a growth year. However, in terms of guidance and any such thing for the entire year, we really do not have that much of visibility. And what I mean by that is visibility into the supply chain.

It is a very uncertain, unpredictable type of an environment, so we are staying away from providing an annual guidance. So, all I can say at this time is that we are expecting fiscal '22 to be a growth year. And if supply chain constraints get retired early, then we can do better. And if they continued to remain constrained, then we will operate in the constrained environment.

And that's where really we -- what we can say at this time, Larry.

Larry Solow -- CJS Securities -- Analyst

Let's start-up the [Inaudible] that's a growth year on an EPS-basis you're saying? Is that [Inaudible]

Sam Maheshwari -- Chief Financial Officer

No, I mean, from a sales [Inaudible] 

Larry Solow -- CJS Securities -- Analyst

OK. that's fine. I just appreciate that clarification. Last question, just longer term, you know, at supply chain issues.

There are further levers on the gross margin side, is that just a mix and, you know, overhead absorption thing? And then, similarly, on the operating side, is that -- sounds like R&D could wave for a little bit up and down, but maybe remain at 8% to 10% range. Is the operating income or margin more of it just in operating leverage on a go-forward basis?

Sam Maheshwari -- Chief Financial Officer

Yeah, so from an operating leverage basis -- thanks, Larry. Yeah, on an operating leverage basis, definitely, the P&L has significant operating leverage. And both of these -- both of our growing segment. So, outside of supply chain and whatever headwinds there are, outside of that, we should see a nice development of operating leverage on our P&L.

Definitely, incremental sales should drive incremental operating income. So, from a longer-term perspective, thinking that way and modeling that way would be fine.

Larry Solow -- CJS Securities -- Analyst

Excellent. I appreciate all the color. Thanks a lot, guys.

Sam Maheshwari -- Chief Financial Officer

Thank you, Larry.

Operator

Our next question is from Jim Sidoti with Sidoti and Company. Please proceed with your question.

Jim Sidoti -- Sidoti & Company LLC -- Analyst

Hi, good afternoon, and thanks for taking the question. I wanted to ask you about inventory because it's down I think almost 40 million from fiscal 2020, and it's only down about 20 million from fiscal 2021. You know, I mean, fiscal '19. What -- why is that? And is that trend going to continue or do you think you will have too much in inventory go forward?

Sam Maheshwari -- Chief Financial Officer

Sure, Jim, let me take that question. So, yes, as you know, we rolled out an initiative to reduce inventory at the beginning of fiscal '21, and we had provided you some color and some guidance on that. And I'm pleased to say that we were able to achieve or overachieve those targets. So, we did well over there.

However, as you rightly pointed out, you know, right now, in this type of supply chain environment, I would rather have a bit more inventory than less. So, my thinking is and how we are planning is that more likely than not that inventory would go up in the remaining -- in the coming quarters. Probably not all the way back to the levels where it was when we started the year, but perhaps a little bit of built up in the inventory. And as I said, we are expecting fiscal '22 to be a growth year.

So, I think that would provide a nice support to our growth, objective here on the top line, and then also provide a little bit more streamlined and efficient operations for our factory. So, we are not necessarily targeting a further reduction in inventory for the upcoming fiscal year. Now, it can move around or bump around here or there from quarter to quarter, but we do not have another initiative for fiscal '22 that we had for '21.

Jim Sidoti -- Sidoti & Company LLC -- Analyst

All right. But even if you don't get that boost to cash flow from the inventory, I mean, it seems like, you know, even if it's not that 92 million of operating cash you had in fiscal 2021, there is going to be significant operating cash generated in fiscal 2022. And with capex spending around 25 million, you know, you're still going to have quite a bit of free cash. You know, what are the uses of that going forward?

Sam Maheshwari -- Chief Financial Officer

Yeah, you're right. We expect to generate positive cash flow coming fiscal year, for sure. Yeah, that's what we are planning at this time. Again, as I have said, that our goal is to fully fund all the operating needs, new technologies, as well as capex that I laid out -- the details that I laid out for capex.

Beyond that, for the excess cash flow, you know, we are allowed to pay down some amount of debt every calendar year. So, that is one opportunity. And if any such decision is made, we will be -- we would go ahead and share that with you as then such a decision is made. So, that opportunity is there.

But broadly, I would say, our focus is to de-lever, whether it is on a net debt basis where the cash is on our balance sheet or we are able to retire the debt, either which way, I think the strategy is to keep on de-levering.

Jim Sidoti -- Sidoti & Company LLC -- Analyst

All right. Thank you. That's it for me.

Sunny Sanyal -- President and Chief Executive Officer

Thank you, Jim.

Operator

[Operator instructions] Our next question is from the Suraj Kalia with Oppenheimer and Co. Please proceed with your question.

Suraj Kalia -- Oppenheimer and Company -- Analyst

Good afternoon, Sunny, Sam. Can you hear me all right?

Sunny Sanyal -- President and Chief Executive Officer

Yeah, hi, Suraj, how are you?

Suraj Kalia -- Oppenheimer and Company -- Analyst

Gentlemen, congrats on a great quarter and excellent progress. Sunny, a bunch of questions for you and a couple for Sam also. So, let me throw out my questions to you first, Sunny. Specifically, you -- this was the first call that I remember in a long time you're spending so much time on AI, you know, and how it could be a significant component of the overall biz.

Maybe you could walk us through how you view Varex's AI, what is the competitive advantage, for example, in lung versus other systems -- other AI systems? That would be one question for you, Sunny. If I could just top on a couple more to you? The cold cathode, what more validation is still needed? And would you venture to first trial it out in the industrial or the medical side? And finally, I'd love to get a little more color on the flexible substrate digital detector. Don't want to get too bogged down on the engineering side, but it's a fascinating concept, and I'd love any color you could provide.

Sunny Sanyal -- President and Chief Executive Officer

OK. So, I'll take it in that sequence. First of all, on AI, Suraj, as we have been in this technology area for quite some time. So, the company that -- as you know, the MeVis, the company that we acquired in Germany that we own 73% of, they've been in the computer-aided detection space for a very long time.

So, they've got a lot of field experience and a lot of in-house experience with AI technology. So, there, we have, you know, we have developed lung screening workstation. So, the difference in our lung screening workstation, what we do versus someone else's, and I can't speak for our competitive relatively. What we do very well is it's a full workflow solution.

AI algorithm -- it's one thing to build the AI algorithms and sell those to OEMs and say, come and get it, versus what we have the full workflow solution designed at being able to -- enable radiologists to do lung screening with high velocity. The same type of workflow and efficiency solution that you see in mammography screening where you need to read at very high speed because there are -- you're -- we anticipate that as the volumes of lung screening increase, that organizations would have to deal with it with limited radiologists and very efficiently. So, that's the main thing. At the end of the day, the radiology group wants -- they want to go through -- they want to see efficiency and productivity in their department.

Secondly, on the clinical side, we believe we've got a very, very robust clinical solution where the combination of the way we present the images for diagnosis, the way we -- the things that we do to help the radiologists such as being able to track progression of tumors over historical, then -- and be able to provide information with automated calculations. We can do volumetric measuring. These are the kinds of things that make it clinically very user-friendly and the radiologists' experience is really, really great. And by the way, this has come from decades of work on these types of workflow solutions.

So, that's basically what we're doing. Now, we're also -- in this particular case, you know, we are taking steps to help the industry with adoption. And that's why we are positioning these technologies in tenders. And as you know, outside the U.S., most of these kinds of programs are initiated by different government health initiatives.

So, in the U.K., in Canada, and other parts of the world, we have been participating in tenders, and largely, to get ourselves out there and provide the momentum for adoption of AI technologies. So, that's -- and then we've continued on with that work with other organ systems. See, there's like liver, dental. And the intention here is broad-based.

One is to be able to market these independently, separately, but also to be able to incorporate these technologies into our broader solutions. So, you know, if you were to -- in fact, we do offer software analysis packages, image processing packages that are included as part of our detectors. So, any of these images can be preprocessed before they even get to a radiologist. And so, if I were to fast forward and say we would continue to stay down on that path and bring more of those capabilities into our broader applications.

OK? So, that was color on AI. Secondly, cold cathode, so then our multimeter nanotube-related X-ray sources. You know, we're -- we continue to push the edges of that technology to make sure that we understand what it's capable of, and that's what we've been doing. And I don't want to share -- you know, I'd given you -- every one a color as to what that meant, and we -- all I would just say is we've continued to make that journey down the path and we're not disappointed.

But we are learning about how -- one, how to make these tubes into more and more complex tubes with a lot more emitters and make them in a way that satisfies our needs to ascertain stability, performance, life, longevity, yield, all those kinds of things. And we are in that lifecycle of our product development lifecycle where this is a good time for us to engage with OEMs, and that's what we're doing. Now, industrial versus medical. You know, we -- the conversations we're having with customers are simultaneously, but it's always convenient for us to put something in an industrial setting where, you know, there are fewer regulatory constraints there, so it's easier for us to try something out in the field and the experience there helps because, you know, we -- that's real-life use and real-life integration activity.

So, that's what we're doing. That's a pretty standard part of our process and journey that we're doing, and, you know, we have not been disappointed so far. And then lastly, the flex substrate.

Suraj Kalia -- Oppenheimer and Company -- Analyst

Yup.

Sunny Sanyal -- President and Chief Executive Officer

Sorry, Suraj.

Suraj Kalia -- Oppenheimer and Company -- Analyst

Yup, go ahead, please.

Sunny Sanyal -- President and Chief Executive Officer

Yeah, flex substrate. So, the flex substrate is -- it's -- you know, you should think about it in terms of when we talk about Z Platform. Z Platform used the new material called IGZO. But the difference between just dropping in an IGZO sensor, we didn't do that.

What we did was we took advantage of the performance that you get from that type of sensor with that material and we designed a whole new platform for dynamic detectors with the Z Platform. It's a whole new simulator, whole new electronics, whole new everything to take full advantage of that platform. Same way with flexible substrate. Flex, by itself, doesn't do much.

I mean, our detectors don't -- you know, the breakage rate -- glass breakage rate is very nominal. Weight savings will be OK. It'll be -- order a few hundred grams, but that wasn't a big deal. What we've done with our new generation of detectors that we are -- we're planning to introduce -- have customer shippable versions available in the middle -- by May or June of this upcoming year is to redesign that radiographic platform with high capabilities.

These would be premium capabilities that would bring down into the radiographic detectors and with lower-cost design, lower-cost supply chain, and the intention here is to attack that space aggressively. So, these will be very high-quality premium detectors. And while we're at it, we decided, hey, we might as well move away from glass onto a flexible substrate and you get the added benefit of robustness in the mechanical design.

Suraj Kalia -- Oppenheimer and Company -- Analyst

Interesting. Hey, Sam, one question for you, and I'll hop back in queue and maybe you already referenced this, so please forgive me if I didn't catch this. So, Sam, one of the things when you joined and you had clearly articulated efforts to improve gross margin and optimize the P&L, and inventory was one component, I believe 25 million or so, that you had articulated. Please correct me if I got the number wrong.

But inventory was one target area. In this environment [Audio gap] chain issues, are you all shifting any LIFO or FIFO base, you know, because the raw materials also, the price is increasing? And if you could help us understand this 5% ESP increase, how sustainable do you think, and is this pass-through in terms of a price increase? Gentlemen, congrats again. Thank you for taking my questions.

Sam Maheshwari -- Chief Financial Officer

Thanks, Suraj. Yeah, that's right, the inventory reduction was one of our initiative for fiscal '21 that we signed up for, and as the results show that we were able to definitely achieve those. Our current situation and our accounting method, the LIFO or FIFO, we're not discussing that. So, I -- we're not looking at changing the accounting method or the inventory standard cost method or inventory relieving method.

So, we plan to continue to follow the same practices that we have followed before. So, that's under LIFO versus FIFO in the inventory. And in terms of the price reduction versus the cost increases, our goal with price increase has been and was when we rolled out the price increase was to pass on the cost increases over to our customers. It's not our initiative to improve gross margin.

For gross margin improvement, we continue to work toward improving factory efficiencies, relaying out the factory, reducing warranty costs, reducing scrap, and improving yield, and all of those initiatives, which are all pretty much determined by us. In terms of price increases, our plan is to maintain the gross margin guidance that we provided you. I should not use the word guidance but gross margin expectations, on a longer-term basis, 35% plus-minus one -- plus-minus 100 basis points. That should continue.

And what we are doing here is to maintain that gross margin expectation and pass on the increase in the materials cost over to customers, and that's how we are looking at pricing. And we are expecting these to remain sustainable. These are not transitory. As you know, some of the costs do not go down.

For example, wage inflation is also something that we are dealing with, and that's not expected to go down. So, from our vantage point, prices that we're rolling out are not transitory, they are permanent. And then subject to other market factors that may come in future, we'll deal with them. But from our perspective, the increase in prices is permanent.

Suraj Kalia -- Oppenheimer and Company -- Analyst

Thank you.

Sam Maheshwari -- Chief Financial Officer

Thanks, Suraj. 

Operator

We have reached the end of the question-and-answer session, and I will now turn the call over to Chris Belfiore for closing remarks.

Chris Belfiore -- Director of Investor Relations

Thank you for your questions and participating in our earnings conference call for the fourth quarter of fiscal year 2021. The webcast and supplemental slide presentation will be archived on Varex website. A replay of this quarterly conference call will be available through November 30 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 13724162. Thank you, and goodbye.

Operator

[Operator signoff]

Duration: 72 minutes

Call participants:

Chris Belfiore -- Director of Investor Relations

Sunny Sanyal -- President and Chief Executive Officer

Sam Maheshwari -- Chief Financial Officer

Frank Pinal -- Jefferies -- Analyst

Larry Solow -- CJS Securities -- Analyst

Jim Sidoti -- Sidoti & Company LLC -- Analyst

Suraj Kalia -- Oppenheimer and Company -- Analyst

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