Earnings Call Transcript - VREX Q4 2021

Operator, Operator

Greetings. Welcome to the Varex Fourth Quarter 2021 Earnings Conference Call. At this time, all participants are in listen only mode. A question and answer session will follow the formal presentation. 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, including supplemental slide presentation can be accessed at Varex’s website at investors.vareximaging.com. The webcast and supplemental slide presentation will be archived on Varex’s website. To simplify our discussions, 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 the calendar year, unless otherwise stated. Please be advised that during this call, we will be making forward-looking statements, which are predictions or projections about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties that could cause actual results to differ materially from those anticipated. Risks relating to our business are described in our quarterly earnings release and in our filings with the SEC. Additional information concerning factors that could cause actual results to materially differ from those anticipated is contained in our SEC filings, including Item 1A, Risk Factors, of our quarterly reports on Form 10-Q and our annual report on Form 10-K. The information in this discussion speaks as of today’s date and we assume no obligation to update or revise 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 their 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 CEO

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 have 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 technologies 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, particularly 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 remained 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 continue to see robust demand 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. Fluoroscopy was 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 remained 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 are 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, Z 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 are excited about the growth potential that AI-aided software represents. Varex’s AI-aided software leverages our more than a decade of field-based experience with software for image analysis and computed detection that is installed on thousands of diagnostic workstations globally. We have been able to apply these competencies in developing AI-aided software for breast, lung, neuro, and liver imaging, and we expect to continue to develop it across various other imaging modalities. With an increasing focus on connectivity and integration, we are happy to be able to offer the software via other clouds. 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 won a tender to provide lung screening software for nine hospitals in the Province of British Columbia, Canada. We expect this win, along with other projects won in Europe and the United Kingdom, to help drive the broader adoption of Veolity over time. In the US alone, there are over 200,000 lung cancer cases and over 60,000 deaths from lung cancer each year. The high mortality rate of about 19% is mainly related to the 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 US, 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 track 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. The global lung cancer screening market is expected to grow at a 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. Increased 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 a 50% incremental margin, an outstanding accomplishment from a period that has been very strong. 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 10-fold 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 at the end of the year was $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 despite supply chain issues, 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 a continued focus on improving profitability. Our fiscal 2022 expenses include fully funding several R&D initiatives that we expect to drive future growth. As we discussed earlier, we're developing several exciting new products, such as photon counting detectors for CT, a family of next-generation radiographic detectors on flexible substrate, and several advanced tube models for CT and cardiovascular applications, as well as AI-aided software and new connectivity and control components. 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 market 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 innovations in X-ray tubes and 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 is 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 thus 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, CFO

Thanks, Sunny, and hello everyone. As a reminder, unless otherwise indicated, I will provide sequential comparisons of our results for the fourth quarter of fiscal year 2021 with those of our third quarter 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 revenues were $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 cover 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 due to 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 of 34%, down 200 basis points from the third quarter as 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 improve efficiencies in our manufacturing. As noted earlier, in 2021, we grew our gross margins by 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 towards 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 year 2021. This impacted gross margin sequentially by about 50 basis points. As we have highlighted since the second quarter, supply chain constraints largely around freight and logistics have 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 continued 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 costs 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 pick 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 lower 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 to drive an 8% increase in operating earnings from the previous quarter to $33 million. Despite the decline in gross 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 the associated trading range of our shares, there was a difference between diluted shares for GAAP and non-GAAP purposes. GAAP share count ignores the bond hedge while the non-GAAP share count includes the economic benefits from the hedge. We have provided a reconciliation between the two at the end of our earnings press release. The appendix of our slides provide the table showing the effects 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 by $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 flow from 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 deliver 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. The 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 a net debt leverage ratio of below 3 times. Fiscal 2021 presented challenges seemingly at every turn from higher than anticipated demand levels to a severely constrained supply chain, but we remain 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 result for Q4 and the context of our expectations for Q1. Our Q4 results came in higher than expected in part because towards the end of Q4, we received some raw material earlier than planned and consequently were 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 dynamic balance between price increases and rising costs; non-GAAP operating expenses are expected to be $45 million to $46 million; a tax rate of about 23% for the 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 tube factory, as well as complete the build-out of our new cable factory in the Philippines. With that, we’ll now open the call for your questions.

Frank Pinal, Analyst

This is Frank Pinal on for Anthony. I guess, first off, congratulations on a very nice quarter again. The first question, I guess, we're seeing a lot of companies touch on supply chain impacts and you sort of touched on it with delays and pricing increases. Just sort of wondering what you're seeing as you were exiting the quarter and how you're sort of thinking about Q4; maybe if you can touch on China, maybe port congestion that's impacting you and perhaps how long do you expect these impacts to persist, just going through mid-2022 to the back half, beyond?

Sunny Sanyal, President and CEO

That's a broad question, and I'll let Sam address the financial implications. The port congestion wasn't an issue for us at one point, but we've transitioned from ocean freight to air freight for all our inbound logistics. Our outbound freight costs are borne by our customers while we handle the inbound materials through air freight, allowing us to bypass delays and congestion at seaports. However, we continue to face supply chain challenges primarily due to inconsistent and unpredictable material supply from our suppliers, which has been a persistent issue for over a year. We're managing the situation, but it is becoming more challenging as more suppliers fall behind. As Sam mentioned, we have been qualifying alternative suppliers, which is an ongoing process that is helping us address the supply gaps.

Sam Maheshwari, CFO

What I can add here is that instead of using ocean freight, we are now using air freight, and that is much more expensive. So 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 later 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 them, but it is definitely a drain on the performance.

Frank Pinal, Analyst

I guess the next question, if you will, if you can touch on underlying demand for CT, also backlog, that would be great. I have one follow-up question after that if possible.

Sunny Sanyal, President and CEO

The demand for CT in China is continuing. I mean, it's been the one thing that's been steady and increasing, driven by, as you know, the 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 we've got several Chinese OEMs; state Chinese OEMs that are designing in our products that started this journey a while ago, and they're continuing to release more systems. So that continues to remain strong. The demand there is robust, and we expect it to continue into the foreseeable future.

Sam Maheshwari, CFO

And Frank, to a question on backlog, I can add that, typically, we have not provided backlog numbers 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. So backlog did increase for Q4 significantly from Q3. But I want to remind you that backlog is not necessarily a very strong predictor of our revenue performance. Nonetheless, backlog was significantly ahead of $300 million, a little closer to $327 million at the end of Q4 versus around $250 million to $260 million 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, Analyst

Just one last one here. I am 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 CEO

It's a novel technology. And as you know, in our business, it takes time for introducing novel technologies, and it also requires working through the B2B OEM channel. After we have the technology and we feel it's ready for our customer consumption, then our customer starts the consultation process to understand what to do with this technology and how to start conceiving applications. I will summarize by saying that we also continue to be excited about this technology. We have been steadily validating the technology itself and assessing the parameters for this technology, the performance parameters and characteristics so that we can have intelligent conversations with our customers about what kinds of applications will be suitable for. So we are at that stage now where I mentioned that we are including our customers into that piece of the work and we are shipping prototypes to prospects who want to evaluate this technology. So that's where we are.

Larry Solow, Analyst

I guess, first question just sort of a general question. It sounds like demand is pretty strong across both segments and most modalities. Other than fluoroscopy, is there anything that's sort of been a laggard? And you did mention, I know, on the industrial side, the cargo and airport security business has been a little bit solid. I guess, anything else that hasn’t really come back from COVID, is there anything that’s just sort of lingering and maybe a little more insight on the industrial side? I know you said NDT is doing well; any other areas that are performing well?

Sunny Sanyal, President and CEO

All modalities did well in the fourth quarter. Fluoroscopy's decline is just timing. In our business, sometimes one quarter you might find one modality was slightly down, and next quarter someone else is slightly down. So there's no pattern there. CT has been strong throughout. Surgery has held steady throughout. Cardiovascular started to come back up as procedure volumes returned. Mammography was slightly slow to recover but now we're seeing strength there as well, and it's returning to good health. So, there’s nothing that I can call out on the medical side that hasn't recovered or hasn't shown strength. Even dental, we had a hard time identifying patterns, because you would move around the globe in different patterns depending on how COVID moved around. But even within dental, we're starting to see that recovery and growth type of mode. On the industrial side, cargo and airport security are moving in the right direction. As you look at our customers’ major OEMs in that space, they're also reporting orders confirming the orders that they have received. So we expect those to translate into shipments for us, as well, soon. Broad-based NDT is doing well, and electronics inspection, battery inspection, our detectors are performing very well in that space.

Larry Solow, Analyst

Regarding guidance, I understand you are only providing quarterly guidance now. There are many factors to consider. Can you help clarify the outlook for the year? Is there any seasonality that still applies? Q1 has typically been slower, but supply chain issues and ongoing COVID effects may have changed that. It appears you have some positive factors ahead, like pricing improvements. How do you anticipate seasonality or supply chain conditions evolving? Will you manage to recover lost revenues? Also, I wonder if R&D expenses might increase. Is Q1 a good indicator for the rest of the year, and should we expect significant improvements or declines? I'd appreciate a broader perspective on this.

Sunny Sanyal, President and CEO

Yes, that's a lot of questions, and a lot of good ones, Larry. So yes, you're right. In general, Q1 is the slow quarter for us. But that is in a demand-constrained environment. In a normal year, there is seasonality due to demand and all of that, so that concept applies. But right now, as we indicated quite clearly, we are operating in a supply-constrained environment. So seasonality goes out the window. Essentially, if the supply chain bottlenecks were not there, then we would be shipping more than what we are guiding. Therefore, not to focus too much on seasonality but maybe perhaps by the following year in 2023, seasonality could come back once all supply chain constraints are removed. In terms of the fiscal year, as it develops, we expect fiscal '22 to be a growth year. However, in terms of guidance, we do not have much visibility due to supply chain unpredictability. All I can say at this time is that we are expecting fiscal '22 to be a growth year. If supply chain constraints get retired early, then we can do better; if not, we will operate in that constrained environment.

Larry Solow, Analyst

So, that's a growth year on an EPS basis you’re saying, is that…

Sunny Sanyal, President and CEO

I mean, on a sales basis…

Larry Solow, Analyst

I appreciate that clarification. For my last question, looking ahead, regarding supply chain issues, are there additional factors that could impact gross margin? Is this primarily related to product mix and overhead absorption? Also, concerning operating expenses, it seems that R&D could be flexible to some extent, potentially staying within the 8% to 10% range. Is the operating income or margin mainly influenced by operational leverage going forward?

Sunny Sanyal, President and CEO

From an operating leverage perspective, definitely, the P&L has significant operating leverage, and both of our segments are growing segments. So outside of supply chain headwinds, 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 would be prudent.

Jim Sidoti, Analyst

I wanted to ask you about inventory because it's down I think almost $40 million from fiscal 2020 and down about $20 million from fiscal 2021. I mean, fiscal ‘19. Why is that, and is that trend going to continue? Do you think you'll have sort of reduced inventory going forward?

Sunny Sanyal, President and CEO

Yes, as you know, we rolled out an initiative to reduce inventory at the beginning of fiscal ‘21, and we achieved or overachieved those targets. However, as you rightly pointed out, in this type of supply chain environment, I would rather have a bit more inventory than less. My thinking is that more likely than not, inventory would go up in the coming quarters. While probably not back to the levels where we started the year, we expect a slight build-up in inventory. We expect fiscal '22 to be a growth year, which should provide support to our growth objectives on the topline and ensure a more streamlined and efficient operation for our factory. We are not necessarily targeting further reduction in inventory for the upcoming fiscal year. However, it may move around from quarter to quarter, but we do not have another initiative for fiscal '22 as we had for '21.

Jim Sidoti, Analyst

But even if you don’t get that boost to cash flow from the inventory, it seems like 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 the CapEx spending around $25 million, you're still going to have quite a bit of free cash. What are the uses of that going forward?

Sunny Sanyal, President and CEO

You're right. We expect to generate positive cash flow in the coming fiscal year, for sure. That's what we are planning at this time. Our goal is to fully fund all operating needs, new technologies, as well as CapEx that I laid out. Beyond that, for the excess cash flow, we are allowed to pay down some amount of debt every calendar year. So that is one opportunity. If any such decision is made, we would go ahead and share that with you as and when such a decision is finalized. Broadly speaking, our focus is to de-lever, whether it is on a net debt basis where the cash is on our balance sheet or if we are able to retire the debt; we intend to keep on de-levering.

Operator, Operator

Our next question is from Suraj Kalia with Oppenheimer & Co.

Suraj Kalia, Analyst

Gentleman, 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, this was the first quote that I remember in a long time, you're spending so much time on AI and how it could be a significant component of the overall business. Maybe you could walk us through how you view Varex's AI, what is the competitive advantage, for example, in lung versus other systems? That would be one question for you, Sunny. If I could just tap on a couple more to you. The core capital, what was validation is still needed; would you venture to first try it out on the industrial or the medical side? And finally, I'd love to get a little more color on the flexible substrates, digital detectors. I don't want to get too bogged down on the engineering side, but it's a fascinating concept and would love any color you could provide.

Sunny Sanyal, President and CEO

So I'll take it in that sequence. First of all, on AI, Suraj, we have been in this technology area for quite some time. The company, as you know, MeVis, which we acquired in Germany, has been in the competitive detection space for a long time. So we’ve got a lot of field experience and in-house experience with AI technology. We have developed a lung screening workstation. The difference in our lung screening workstation or what we do versus someone else's AI algorithms is that we provide a full workflow solution. While it's one thing to build the AI algorithms and sell those to OEMs and say, come and get it, we have designed a full workflow solution to enable radiologists to perform lung screening with high velocity. We anticipate that as the volumes of lung screening increase, organizations will have to deal with limited radiologists and will need to work efficiently. That’s the main thing even if they want to, the way radiology groups want; they want to see efficiency and productivity in their department. Secondly, on the clinical side, we believe we’ve got a very robust clinical solution, as well, combining the way we present images for diagnosis, as well as the things that we do to help the radiologists, such as tracking the progression of tumors over historical data and providing information with automated calculations. We can do volumetric measuring, and these are the kinds of things that make it clinically user-friendly, enhancing the radiologist experience, which is crucial. This comes from decades of work on these types of workflow solutions. We are also in the process of helping the industry with adoption, which is why we position these technologies in tenders. Most of these tender programs are initiated by different government health initiatives outside the US. So we have provided momentum for the adoption of AI technologies in regions like the UK, Canada, and other parts of the world. We have continued to work with other organ systems, like liver and dental, and our intention here is broad-based. One is to market these independently, and separately, but also to incorporate these technologies into our broader solutions. We do offer software analysis and image processing packages that are part of our detectors. These images can be pre-processed, enhancing our capabilities. Now, regarding cold cathodes and nanotech, we continue to push the edges of that technology to make sure we understand what it's capable of, and we've been doing that without disappointment. We are learning how to develop these tubes into more complex tubes with more emitters and ascertain their stability, performance, longevity, and yield. We are in an important life cycle of product development, engaging with OEMs and shipping prototypes to prospects. Lastly, on flexible substrates, you should think about the Z platform. They use the new material called IGZO. The difference between just dropping in an IGZO sensor is that we redesigned a whole new platform for dynamic detectors with the Z platform, including new simulations and electronics to leverage the performance of that material effectively. Similarly, with flexible substrates, we didn't simply use them; we designed a new generation of radiographic detectors that will be premium capabilities bringing significant value into the radiographic detectors with lower cost designs and supply chains. Our intention is to attack that space aggressively and market those as high-quality, premium detectors.

Sam Maheshwari, CFO

One question for you and I'll hop back in queue. Maybe you already referenced this, so please forgive me if I didn't catch it. One of the things when you joined, you had clearly articulated efforts to improve gross margin and optimize the P&L, and inventory was one component, I believe around $25 million that you articulated—and please, correct me if I got the number wrong—but inventory was one target area. In this environment, supply chain issues, are you shifting any LIFO, FIFO base, because the raw materials are also seeing price increases? And if you could help us understand the 5% ASP increase, how sustainable do you think is this pass-through in terms of a price increase? Yes, the inventory reduction was indeed one of our initiatives for fiscal '21, and we were able to achieve that. However, our current situation with respect to LIFO and FIFO, we are not looking at changing the accounting method or our inventory standard cost method. We plan to continue to follow the same practices we have used previously. On the pricing side, our goal with the price increase was primarily to pass on the cost increases over to our customers. It's not an initiative solely for improving gross margin. For improvements, we are focusing on factory efficiencies, layout, reducing warranty costs, scrap, and improving yield, determined internally. In terms of these price increases, we intend to maintain the long-term gross margin expectation we outlined earlier; those should remain sustainable. Some cost increases we expect are not transitory; for example, wage inflation, which will have lasting effects. The prices we are rolling out are permanent.

Operator, Operator

We have reached the end of the question-and-answer session. 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 for participating in our earnings conference call for the fourth quarter fiscal year 2021. The webcast and supplemental slide presentation will be archived on Varex's website. A replay of this quarterly conference call will be available through November 30th and can be accessed at the company's website or by calling 877-660-6853 from anywhere in the US or 201-612-7415 from non-US locations. The replay conference call access code is 13724162. Thank you, and goodbye.

Operator, Operator

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