STERIS Q4 2022 Earnings Call Transcript

Quartr
Provided by Quartr
May 12, 2022

There are 8 speakers on the call.

Operator

Good day, and welcome to the STERIS Plc Fourth Quarter 2022 Results Conference Call. All participants will be in a listen only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Julie Winter with Investor Relations.

Operator

Please go ahead.

Speaker 1

Thank you, Chad, and good morning, everyone. As usual, speaking on today's call will be Mike Tokich, our Senior Vice President and CFO and Dan Crescio, our President and CEO. I do have a few words of caution before we open for comments. This webcast contains time sensitive information that is accurate only as of today. Any redistribution, retransmission or rebroadcast of this call Without the expressed written consent, as tariffs is strictly prohibited.

Speaker 1

Some of the statements made during this review are or may be considered forward looking statements. Many important factors could cause actual results to differ materially from those in the forward looking statements, including without limitations, Those risk factors described in STERIS' securities filings. The company does not undertake to update or revise any of these forward looking statements as a result of new information or future events or developments. STERIS' SEC filings are available through the company and on our website. In addition, on today's call, non GAAP financial measures, including adjusted earnings per diluted share, adjusted operating income, Constant currency organic revenue growth and free cash flow will be used.

Speaker 1

Additional information regarding these measures, including definitions, Is available in today's release, also along with reconciliations between GAAP and non GAAP financial measures. Non GAAP financial measures are presented during this call with the intent of providing greater transparency to supplemental With those cautions, I'll hand the call over to Mike.

Speaker 2

Thank you, Julie, and good morning, everyone. It is once again my pleasure to be with you To review the highlights of our Q4 performance. For the quarter, constant currency organic revenue increased 11%. Growth was driven by organic volume as well as 120 basis points of price. Acquisitions added approximately $253,000,000 to revenue in the quarter, which is broken down by segment in the press release tables.

Speaker 2

Gross margin for the quarter increased 120 basis points compared with the prior year 45.5 percent as favorable productivity pricing and acquisitions were somewhat offset by higher material and labor costs. We continue to face increased material labor costs, which totaled about $20,000,000 in the quarter as anticipated. EBIT margin for the quarter was 23.6 percent of revenue, an increase of 130 basis points versus the prior year. This is impressive performance as operating expenses, including R and D increased, plus the continued headwind from supply chain and inflation. The adjusted tax rate in the quarter was 22.8%.

Speaker 2

Net income in the quarter was 205 point $4,000,000 and earnings per diluted share were $2.04 At the end of the fiscal year, cash totaled $348,000,000 We continue to focus on debt repayment as evidenced by our leverage ratio being now under 2.4 times at the end of the fiscal year. Our focus on debt reduction provides us flexibility to continue making investments in growth capital expenditures and allows us many opportunities to continue to expand our businesses. Year to date capital expenditures totaled 200 $87,600,000 while depreciation and amortization totaled $553,100,000 Free cash flow for the year was $399,000,000 As anticipated, this is a decline from the prior year due to costs associated with the acquisition and integration of Cantel along with higher capital spending year over year. As we look forward to fiscal 2023, we anticipate free cash flow generation of approximately $675,000,000 As the majority of costs associated with the acquisition and integration of Cantel have occurred, we also expect interest expense To be higher year over year as rates continue to rise. Total non operating expenses net Is anticipated to be about $95,000,000 In addition, we expect to continue reinvesting in our businesses with capital expenditures totaling approximately $330,000,000 With that, I will turn the call over to Dan for his remarks.

Speaker 2

Thanks, Mike, and good morning, everyone.

Speaker 3

Thank you for making the time to join us to hear more about our fiscal 2022 performance And our outlook for fiscal year 2023. As I look back on the year of fiscal 2022, It was a remarkable year for STERIS. Not only did we navigate year 2 of a global pandemic, but we also completed the acquisition of Cantel while integrating Key Surgical and successfully transition leadership, all while growing faster than anticipated. I want to start by thanking the people of STERIS for all they have done and continue to do to support our customers and each other. Without all of you, we would not be where we are today.

Speaker 3

We started fiscal 2022 with an expectation of 8% to 9% Constant currency organic revenue growth for the year. After increasing our outlook twice this year, we ended the year with 13% Constant currency organic revenue growth, well above our increased outlook. This growth was driven by continued Outperformance of our AST segment, double digit growth in Healthcare and solid mid single digit growth in the Life Sciences, While dental is not yet included in the constant currency organic revenue growth, the segment grew 4% year over year since the time of acquisition in June. From a profit perspective, we ended the year with operating margins up 100 basis points, Despite absorbing about $45,000,000 in unplanned supply chain and inflation costs related to labor. Helping to offset those costs, we were successful in overachieving our fiscal 2022 cost synergies targets for the Cantel acquisition, which added approximately $40,000,000 to our fiscal 2022 results.

Speaker 3

Adjusted earnings per diluted share of $7.92 increased 28% compared with fiscal 2021 and reflect a new record for STERIS. Turning to fiscal 2023. At a high level, we expect another very strong growth year for our business. Our outlook for total revenue calls for approximately 12% growth, which includes 2 additional months of the Cantel acquisition, offset by the impact of the Renal Care divestiture as well as approximately $30,000,000 in unfavorable foreign currency. Excluding all that, we anticipate constant currency organic revenue growth of approximately 11%.

Speaker 3

Importantly, this outlook assumes that the procedure volumes will normalize in the U. S. And that we do not experience any significant Our constant currency organic Revenue outlook reflects volume growth and includes 200 basis points of favorable pricing. Pricing is essential to help offset The increased cost year over year. For fiscal 2023, we expect an incremental $70,000,000 in extraordinary Supply chain and labor inflation costs above the $45,000,000 we occurred in fiscal 2022.

Speaker 3

This is in addition to our normal low single digit annual inflation amounts, all is included in our outlook, which we will work to overcome every year. In addition to the anticipated headwinds from supply chain and inflation, Our fiscal year 2023 operating expenses will be higher as we get back to spending on travel, sales and marketing and other expenses. R and D spending is also anticipated to be higher as we continue to develop and bring new products to our customers. Offsetting those headwinds, to some extent, will be cost synergies from the integration of Cantel, which is expected to be incremental by approximately $50,000,000 from the fiscal 2022 levels. By the end of fiscal 20 23, we will be approaching $100,000,000 in total cost synergies achieved.

Speaker 3

Taking into consideration all of the puts and takes, We expect to show modest operating margin growth in fiscal 2023. Our full year earnings per diluted share outlook Is anticipated to be in the range of $8.55 to $8.75 or 8% to 10% growth over fiscal 2022. Given all the moving pieces, we are pleased with this bottom line growth outlook. As usual, the range does provide us some conservatism on the low end, but given all the uncertainty that exists, we believe it is warranted. All in all, fiscal 2023 is expected to be another record year for STERIS.

Speaker 3

Our teams and our portfolios continue to come together to better meet the needs of our customers. And the breadth of our offering allows us to take advantage of several significant trends in the industry by leveraging our relationships to cross sell within the business segments. I recently shared with our sales team in our first in person global meeting in 3 years That we honestly believe that STERIS is positioned better today to meet the needs of our customers than ever before in history. That concludes our prepared remarks for the call. And Julie, please give the instructions so we can begin the Q and A.

Speaker 1

Thank you, Mike and Dan, for your comments. Chad, if you would give me instructions, we'd be happy to get started.

Operator

Certainly. And the first question will be from Chris Cooley from Stephens. Please go ahead.

Speaker 4

Good morning. Thanks for taking the questions and congratulations on a stellar year there in fiscal 'twenty Just 2 for me, if I may, here this morning. First, just in thinking about kind of how you're looking at the year Going forward, 11% constant currency growth obviously is a lot higher than what we've historically seen the company Start out with, admittedly, there's some different aspects to the business. Just would appreciate if you can maybe Call out where you're seeing strength, where you need to see some improvement just from operationally from a divisional Perspective. So we can kind of think about that in terms of the drivers both of growth and then as a result margin as we go through the year?

Speaker 4

And then I've got a quick follow-up. Thanks.

Speaker 3

Yes. Thanks, Chris. This is Dan. Thank you for the question. In short, we're seeing A fairly robust recovery in procedure volumes on a quarter to quarter basis, as we move back in To more normalized volume in terms of pre COVID levels.

Speaker 3

We're not there yet. We still have quite a ways to go. And I think that The real governor on the recovery of those rates is going to be staffing and the challenges that's generally present in the healthcare industry today, in particular in the hospital segment. Having said that, as those volumes return, that significantly benefits both our Global Healthcare business as well as the AST business. And we've seen in the last couple of quarters, a recovery of more and more devices Coming through AST in particular that are more highly elective high value type devices.

Speaker 3

So ortho spine things like that of that nature. So as those procedures begin to recover and then start working off what's been a couple of year backlog of pent up demand, We're seeing higher growth opportunities than we've seen maybe in the past. In addition to that, we're coming into the year with all time Record backlog from a capital equipment perspective. And as we hope to flush that through over the course of the year, That will obviously be a bit of a tailwind for us in terms of our revenue growth.

Speaker 4

Appreciate the color. And then just as my follow-up, And I appreciate all the detail here, but a number of puts and takes when you look down to the middle of the P and L As we go into fiscal 2023, just kind of curious, you're talking about a return to kind of normalcy when I think about SG and A more broadly, higher R and D as well. Just I guess directionally, How much of this is a return to normal? How much of this is incremental investment that you're making for kind of the Sustainability of the growth of the business or was the business maybe underinvested in over the course of The last 18 months to 24 months, just trying to get a better feel for what kind of structurally we should be thinking about longer term just from an Thanks, Rick. Thank you.

Speaker 2

Yes. Chris, this is Mike. I would say that the majority of what we're going to experience at least And the SG and A side is more a return to normal. I would not say that we were under invested by any means. And as Dan said in his prepared remarks, Yes.

Speaker 2

We've had our 1st sales meeting in 3 years. So you can imagine the expense of that compared to the last 2 years that we didn't have that. So those are the types of increase We're talking about where you're going to see a little bit of a stepwise change though is in R and D. R and D, we anticipate growing by double digits in fiscal 2023, so we continue to make investments in R and D to bring new products across all of our businesses. So that is, if you look at the 2, A stepwise change that we are continuing to invest for the long term.

Speaker 2

Not that we were under invested by any means, we just think there's a lot more That we can bring forth, especially with the acquisition of Cantel.

Speaker 4

Appreciate that, Mike. Thanks so much. And again, congratulations on a great year.

Speaker 2

Thanks, Chris. Thanks, Chris.

Operator

The next question comes from Mike Matson with Needham and Company. Please go ahead.

Speaker 5

Yes. Thanks for taking my questions. I guess I'll start with just the Q1 in 2023, you've got a bit of a tougher organic Comp, I think. So, I mean, I didn't hear any kind of directional commentary around where you expect the revenue. So, I mean, is it safe to assume you're comfortable where consensus was sort of modeling things?

Speaker 5

I mean, I'd assume it's a lower you're expecting lower organic Growth in the Q1 than the remainder of the fiscal year.

Speaker 2

Yes. Mike, we have this is Mike Stokes. We have not made any comments. But to give you a little bit more Color to help you with your modeling. We would suggest that from a first half versus second half, we're about 45% first half, 55% second half, which is typical of how we operate.

Speaker 2

And to your point, I think I would say you are correct. We do have a little bit of a tougher comparison in Q1, but we're not going to give quarterly guidance at this point in time Nor have we in several years.

Speaker 1

Just to clarify, that's what is earnings.

Speaker 2

Yes, you're correct.

Speaker 5

Okay, got it. That's helpful. All right. And then you mentioned that there are some trends that in the industry that are helping I was wondering if you could just talk a little bit more about that. I'd assume one of them is the trend towards ASCs where the ASCs kind of have to get outfitted with cleaning and sterilization And whatnot, but maybe just talk about some of those industry wide trends.

Speaker 3

Yes, that is one clearly. Sorry, this is Dan. And there's an awful lot of growth going on in investment both in acute care and in ASCs across the U. S. In particular and we're starting to see the recovery in Europe.

Speaker 3

So we've been really well positioned with our portfolio products in particular with SPD and also from an OR perspective Over the past few years and we're nicely positioned to fill that need and that growth that we're seeing as it comes. The other sort of tailwind that we're getting is, I mentioned before, it's just general procedural recovery, which drives our consumables, it drives our services, it drives our AST business. So that's generally beneficial for STERIS whenever we see procedure rates on the rebound. And then sort of last but not least, there's no shortage of investment going on in pharma in In terms of aseptic manufacturing as it relates to biopharma and to some extent vaccine as well. So we have an awful lot of backlog in life science that's going to flush This year as it relates to some of the expansions that and investments we've seen going on in the industry.

Speaker 3

And as those investments come online, that's a tailwind for us with Our consumables business as they start to consume our chemistries and our packaging solutions. Okay.

Speaker 1

Got it. And obviously with an AST as well.

Speaker 3

Yes. And obviously with an AST, that's driving Biopharma and procedure recovery is a tailwind for our AST business.

Speaker 5

Okay, got it. Thanks. And then Just as far as the free cash flow guidance goes, I mean, I'm having a little trouble getting to the $1,000,000,000 of Cash flow from operating activities in my model, I mean, I'm coming in higher than that, but the only way I can kind of get there is assuming your working capital was up a Fair bit. I mean is that a reasonable assumption? And is that maybe you're stocking up on inventory and things like pre buying stuff because of the supply chain issues?

Speaker 5

We've heard that from other companies.

Speaker 2

Yes, Mike, that's exactly right. And we have been doing that for probably the last 18 months, 2 years where we've continued to carry higher levels of inventory. When we shift the backlog, obviously, the inventory and if supply chain does It's a little bit easier. We will actually be able to bring that inventory level down as we

Speaker 3

go throughout the year. Our philosophy on inventory has gone from just in time to just in case. So there's an awful lot of contingency and supply chain continuity built into our inventory levels right now.

Speaker 5

Okay, got it. Thank you. You're welcome.

Operator

The next question is from Matthew Mishan from KeyBanc. Please go ahead.

Speaker 5

Hey, good morning and thank you for taking the questions. I just want to start first with the Healthcare Capital Equipment. At least versus our model, it looks like It came in a little late in the Q4. Did some of the backlog shift from the Q4 into FY 2023.

Speaker 2

Yes, Matt. As we've been talking about the last couple of quarters, we have seen roughly $30,000,000 ish, that did not ship that would have been scheduled to ship on a normal course, if you will.

Speaker 5

Okay. And then if you look at it and you say that's like adds about a percent, as you compare the 11% organic growth For FY 2023 to what is a more sustainable level of organic growth, we kind of back out That capital equipment, I guess price is probably not 200 basis points moving forward. Just what do you How do you look at what is a sustainable level of organic growth compared to the 11% for 2023?

Speaker 2

Yes. I would say, Matt, we are still in the mid to high single digit revenue growth on our long term aspirations. Obviously, we've done better than that over the last several years. But in general, we would still stay with that Forecast or that thinking from a long term perspective.

Speaker 5

Okay. And then just Dan, just your longer term thoughts on hospital capital spending As it progresses through the year, I think we've seen a couple of different opinions from some companies on kind of Where that's potentially moving?

Speaker 3

Yes. And we've seen those opinions as well. I think some of the differences is The capital equipment that STERIS is selling is typically $20,000 to $100,000 pieces of equipment. So these aren't $1,000,000 to $2,000,000 machines. And the other point I would make is, what everything we sell basically is Seadrill rate driven and it's almost like a utility at times for the hospitals.

Speaker 3

They have to have it in order for them to accommodate an increase in surgical procedures, Whether that's lights and tables or whether that's stuff in the SPD. So generally speaking, Given the cost of our equipment and sort of the utility of it in nature, we see continued strong investment. And how long it will last? I don't know. But we don't see it changing anytime in the near future.

Speaker 5

Excellent. Thank you very much.

Operator

The next question is from Michael Pollack with Wolfe Research. Please go ahead.

Speaker 6

Good morning. Thank you for taking the questions. One clarification on the response to Mike Matson's question, the 45, 55, Mike Tokich, is that was that a comment on revenue progression 1H2H or EPS?

Speaker 2

Mike, that was on EPS. And welcome back, Mike. Welcome back to covering us.

Speaker 6

Thank you. Those 3 mics in my first question too. Three mics too many. And maybe on fiscal 2023, to level set comments or frameworks This have been made in the past. I don't think the I'm not struggling too much, but would you be willing to level set in $5,100,000,000 give or take of imputed revenue for fiscal 2023, how that splits out across the segments just so we can Work the model a little bit more precisely?

Speaker 2

We have not done that, Mike. And I think at this point We will not, but I will tell you that for the most part, if you look at growth, Healthcare is going to be exceeding their normalized growth. I would say life sciences will be somewhere in maybe a little bit better than the normalized growth. AST will be And it's normalized growth and then obviously dental, we still don't have a true comparison at that point in time. So

Speaker 6

Okay. Dental, what's the early assessment of Dental? I would say this is the one piece of the acquisition that hasn't Impressed yet. Kind of how do you feel about that business? What are the work streams and initiatives for fiscal 2023 As you continue to integrate it and learn that market?

Speaker 3

Yes. This is Dan, Mike. So yes, we're happy with the business. I would say it is more affected recently in particular with the surge of omicron That we saw in the January early February timeframe. And unlike healthcare where it had very little effect, Just the broad level of infections across the U.

Speaker 3

S. In particular ended up postponing or delaying a lot of procedures in the dental space. And If you want to fact check that, call your dentist today and see if you can get in before July because there's a lot of pent up demand in terms of lost time in the first Couple of months anyways of this calendar year. So we like the business. We think there's a ton of operating opportunities in In terms of driving efficiencies through lean and continuous improvement, that's going to take us some time to ring out and make Business is a little more efficient in terms of how they serve their customers.

Speaker 3

But other than that, it's on a steady track of recovery in terms of demand barring what we saw the 1st couple of months of the calendar year.

Speaker 2

And Mike, just to add to that a little bit. I mean, we grew 4% Since the acquisition, which is a little below to Dan's point because of some of the COVID impacts, which is a little bit below the mid single digits anticipation that we would have for that segment to give you some further clarity. That we would have for that segment to give you some further clarity.

Speaker 6

4%, that's like a pro form a growth rate for the business. Okay. And if I can do one more, the comments on R and D are interesting. Obviously, STERIS is not overly reliant on any single product, and so I don't wish to over The importance of any single product category with this question, but I have noticed that you have recently launched relatively recently, I think this Your late last single use reader scope and it's always a topic that seems to come up From time to time, I'd just be curious about your efforts there and if this launch is An appetizer to some more products in that single use scope category over time. Thank you so much for taking the questions.

Speaker 3

Sure, Mike. So yes, we're in a limited market release right now in terms of the new scope. And we've received a lot of positive feedback And it's early, early days at this point. And we'll see how that goes and how it progresses over time. What I would say is that STERIS is uniquely positioned with our IMS business and vast understanding and engineering that we have around scope design from our repair perspective.

Speaker 3

And that collaboration with the commercial teams has Put us in a nice position in the urology space. And so as that product begins to go into more realistic launch, we'll be able to provide some update and At this point, it's just too early days for us to discuss it.

Operator

Thank you. And the next question will come from Dave Windley from Jefferies. Please go ahead.

Speaker 7

Hi, thanks for taking my questions. Most of them follow ups. You've commented on the recovery in volumes broadly and picking predominantly healthcare And ASP, I'm wondering if you could comment on whether you see the primary drivers of those volumes being Recovery of pent up demand as you've mentioned, how much might be market share gains and any other contributors to that?

Speaker 3

I mean, I think in terms of procedure volume, that's pretty straightforward. As you know, we're back now in the U. S. Market anyway somewhere around 95% Pre COVID, depending on where you are, region to region, some hospitals may be operating at 100%, others are operating at 90%. And over time, I think as provided the staffing can step back up in terms of meeting the full demand, We'll see that improve beyond what we saw pre COVID because there is a lot of pent up demand.

Speaker 3

But there's also a lag now in terms of intake with the hospitals, getting people back into the system where they're diagnosing disease and moving them towards surgery where necessary. That is slower to recover as well. So it's going to take some time. In terms of overall rates and demand on the different businesses, in terms of the overall growth rate, I do believe we're taking a bit Chair across the majority of the businesses here at STERIS. We've discussed that in the past and we've made very significant investments in our portfolio As it relates to Healthcare and Life Sciences over the years, and also in significant capacity expansion investments AST and consequently, I think we're doing a little bit better than market in those spaces.

Speaker 7

Great. Thanks. And follow-up, different topic around capital structure. You mentioned leverage, I think, was 2.4 times, Mentioned rising interest rates and a big recovery in the coming year in your free cash flow expectations. Maybe just talk about general capital deployment priorities and is kind of getting that how much floating interest Great debt do you have and is the rising interest rate environment encouraging you to pay off more of that more quickly?

Speaker 2

Yes. So I would say that in general, as we are anticipating about $675,000,000 in free cash flow that our capital priorities Have remained basically the same for the last decade or more. We're off the top. We believe in increasing our dividends. We've done that 16 years in a row.

Speaker 2

Next would be to continue to invest in ourselves and we're continuing to do that. We've got about Anticipating about $335,000,000 in CapEx, which is almost $50,000,000 higher compared to the prior year. And we a lot of that CapEx is And it will be continued directed into our AST segment as we continue to expand our facilities And our opportunities in that segment. 3rd would be looking towards M and A. We've done over 50 transactions in the last 10 years or so.

Speaker 2

Most of those are tuck ins in nature. And I would imagine that most of those in the future As we continue down the M and A path, we'll be tuck ins. And then finally, just from a repurchase share repurchase standpoint, Just to offset dilution and we have that built into our plan for this year. We did do about $25,000,000 of share repurchases in Q4, but we had a hiatus on share repurchases for the last 18 months or 2 years. So from a prioritization standpoint, that is how we operate and how we have continued to operate over the last several years.

Speaker 1

And from a debt.

Speaker 7

Got it. Thank you.

Speaker 1

Dave, just I think you asked about debt, about a quarter of

Operator

The next question is a follow-up from Chris Cooley from Stephens. Please go ahead.

Speaker 4

Thanks for taking the follow-up here. Just two quick follow ups for me, if I may. Could you speak to the margin profile in the dental business? I'm just trying to get a better sense of We saw sequential progression downward throughout fiscal 2022. How much of that decline in the 4th quarter was volume Related, it does sound like that impacted you from a response to a prior question, but just when we should maybe start to expect stabilization there or Maybe a lift better.

Speaker 4

And then just a quick follow-up, I'd be curious if you could discuss or Provide any additional color when you think about the AST build out that continues to take place, emphasis on different sterilization modalities, In particular, x-ray here in the United States and abroad. Thanks so much.

Speaker 2

Dan, I'll take the That's the one and I'll give you the AST one, if that's okay?

Speaker 7

Yes, sounds good.

Speaker 2

On the margin profile of Dental, Chris, you are correct. We have seen a In our EBIT margins in that business, in the Q1 that we had dental, they were still Not being impacted, like the rest of the business from a materials and labor inflationary standpoint, that has Changed dramatically in the back half of our fiscal year. So that is one large driver Impact negative impact to dental. And then as we talked about earlier, volumes with patients has definitely had a negative impact on that business. So I would say that in general, we would look to have dental above our corporate average as we continue to Streamline that and get more ingrained in the operations of that business longer term, but definitely volume and then the inflation is definitely having a larger impact on that segment on its own.

Speaker 2

Understood.

Speaker 3

Yes. And Chris, On the AST question, we're in the process of a pretty significant build out across our network and actually across

Speaker 6

multiple technologies. We have a

Speaker 3

few e beam plants going in. We've got a couple of We have a few e beam plants going in. We've got a couple of EO expansions, in addition to the numerous x-ray Facilities that are currently in one phase of build or another, which construction during the COVID environment and labor shortages It's been nothing short of challenging for the last couple of years, but it's definitely looking up recently. So In particular in the U. S, there's 3 facilities that will come online over the next couple of years.

Speaker 3

The earliest will be late, Very late this fiscal year most likely in Illinois. And then followed by either California or Chester, New York.

Speaker 4

Thank you.

Operator

Ladies and gentlemen, this concludes our question and answer Session, I would like to turn the conference back over to Julie Winter for any closing remarks.

Speaker 1

Thanks everybody for taking the time to join us this morning. We look forward to

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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Earnings Conference Call
STERIS Q4 2022
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