STERIS plc (STE) 2022 Q4 法說會逐字稿

Good day, and welcome to the STERIS plc Fourth Quarter 2022 Results Conference Call. (Operator Instructions). Please note this event is being recorded. I would now like to turn the conference over to Julie Winter with Investor Relations. Please go ahead.

Thank you Chad, and good morning everyone. As usual, speaking on today's call would be Mike Tokich, our Senior Vice President and CFO; and Dan Carestio, our President and CEO. I do have just 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 express written consent of STERIS is strictly prohibited. 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 limitation, those risk factors described in STERIS' securities filings. The company does not undertake to update or revise any 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. 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 financial information used by management and the Board of Directors in their financial analysis and operational decision-making.

With those cautions, I will hand the call over to Mike.

Thank you, Julie, and good morning, everyone. It is once again my pleasure to be with you this morning to review the highlights of our fourth quarter 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 million to revenue in the quarter, which is broken down by segment in the press release tables. Gross margin for the quarter increased 120 basis points compared with the prior year to 45.5% 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 million in the quarter as anticipated. EBIT margin for the quarter was 23.6% of revenue an increase of 130 basis points versus the prior year.

This is impressive performance as operating expenses, including R&D increased plus the continued headwind from supply chain and inflation. The adjusted tax rate in the quarter was 22.8%. Net income in the quarter was $205.4 million and earnings per diluted share were $2.04.

At the end of the fiscal year, cash totaled $348 million. We continue to focus on debt repayment as evidenced by our leverage ratio being now under 2.4x 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 $287.6 million, while depreciation and amortization totaled $553.1 million. Free cash flow for the year was $399 million. 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 '23, we anticipate free cash flow generation of approximately $675 million 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 nonoperating expenses net is anticipated to be about $95 million. In addition, we expect continue -- to continue reinvesting in our businesses with capital expenditures totaling approximately $330 million. With that, I will turn the call over to Dan for his remarks.

Thank you, Julie, and good morning, everyone. It is once again my pleasure to be with you this morning to review the highlights of our fourth quarter 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 million to revenue in the quarter, which is broken down by segment in the press release tables. Gross margin for the quarter increased 120 basis points compared with the prior year to 45.5% 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 million in the quarter as anticipated. EBIT margin for the quarter was 23.6% of revenue an increase of 130 basis points versus the prior year.

This is impressive performance as operating expenses, including R&D increased plus the continued headwind from supply chain and inflation. The adjusted tax rate in the quarter was 22.8%. Net income in the quarter was $205.4 million and earnings per diluted share were $2.04.

At the end of the fiscal year, cash totaled $348 million. We continue to focus on debt repayment as evidenced by our leverage ratio being now under 2.4x 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 $287.6 million, while depreciation and amortization totaled $553.1 million. Free cash flow for the year was $399 million. 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 '23, we anticipate free cash flow generation of approximately $675 million 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 nonoperating expenses net is anticipated to be about $95 million. In addition, we expect continue -- to continue reinvesting in our businesses with capital expenditures totaling approximately $330 million. With that, I will turn the call over to Dan for his remarks.

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

(Operator Instructions) And the first question will be from Chris Cooley from Stephens.

Congratulations on a stellar year there in fiscal '22. 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 higher than what we've historically seen the company start out with.

Admittedly, there's some different aspects to the business. I 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. And then I've got a quick follow-up.

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 into more normalized volume in terms of pre-COVID levels. 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 health care industry today, in particular in the hospital segment. Having said that, as those volumes return, that significantly benefits both our global health care 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, so orthospine things like 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.

I 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&L as we go into fiscal '23. Just kind of curious, you're talking about a return to kind of normalcy when I think about SG&A more broadly, higher R&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 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 expense rate?

Yes, Chris, this is Mike. I would say that the majority of what we're going to experience at least in the SG&A side is more a return to normal. I would not say that we were underinvested by any means. And as Dan said in his prepared remarks, we've had our first 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 increases we're talking about. Where you're going to see a little bit of a step-wise change is in R&D. R&D, we anticipate growing by double digits in fiscal '23.

So we continue to make investments in R&D to bring new products across all of our businesses. So that is, if you look at the 2, a step-wise change that we are continuing to invest for the long term. Not that we were underinvested by any means, we just think there's a lot more opportunity that we can bring forth, especially with the acquisition of Cantel.

The next question comes from Mike Matson with Needham & Company.

Yes. I guess I'll start with just the first quarter in '23, 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 for sort of modeling things? I mean, I'd assume it's a lower -- you're expecting lower organic growth in the first quarter than the remainder of the fiscal year.

Yes, Mike, we have -- this is Mike Tokich. 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. 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.

And just to clarify, that puts as earnings.

Yes, you're correct.

Okay. Got it. That's helpful. All right. And then you mentioned that there is some trends in the industry that are popping, STERIS, I just wondering if you could just talk a little bit more about that. I'd assume one of them is the trend towards ASCs where ASC they kind of have to get how fitted with cleaning and sterilization equipment and whatnot. But maybe you can just talk about some of those industry-wide trends.

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. So we've been really well positioned but with our portfolio of 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, as I mentioned before, is 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 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 through this year as it relates to some of the expansions that the investments we've seen going on in the industry. 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.

And (inaudible) AST as well.

Yes. And obviously, within AST, that's driving biopharma and procedure recovery is a tailwind for our AST business.

Okay. Got it. And then just as far as the free cash flow guidance goes, I mean, I'm having a little trouble getting to the $1 billion 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 is of a fair bit. I mean, is that a reasonable assumption? And is that maybe you're stocking up on inventory and things with prebuying stuff because of the supply chain issues. We've heard that from other companies. .

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 ship the backlog obviously, the inventory and if supply chain does get a little bit easier, we will actually be able to bring that inventory level down as we 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.

Next question is from Matthew Mishan from KeyBanc.

I just want to start first with the Healthcare capital equipment. At least versus our model, it looks like it came in a little light in the fourth quarter. Did some of the backlog shifts from the fourth quarter into FY '23?

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

Okay. And then if you look at it and you say that's like (inaudible) -- as you compare the 11% organic growth for FY '23 to what is a more sustainable level of organic growth you kind of back out that capital equipment. I guess price is probably not 20 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 '23?

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.

And then just, Dan, just your longer-term thoughts on hospital capital spending 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.

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 $million to $million machines. And the other point I would make is what everything we sell basically is procedural rate driven, and it's almost like a utility at times for the hospitals.

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.

The next question is from Michael Polark with Wolf Research.

One clarification on the response to Mike Matson's question. The 45, 55 (inaudible) . Is that -- was that a comment on revenue progression, 1H, 2H or EPS?

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

Those 3 mics in my first question, too. 3 mics too many. And maybe on fiscal '23 to level set comments or frameworks like 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 your $5.1 billion, give or take, of imputed revenue for fiscal '23, how that splits out across the segments, just so we can work the model a little bit more precisely?

We have not done that, Mike. And I think at this point in time, we will not. But I will tell you that for the most part, if you look at growth, health care 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 at its normalized growth. And then obviously, dental, we still don't have a true comparison at that point in time. So.

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 '23 as you continue to integrate it and learn that market?

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 or we took February time frame. And unlike health care where it had very little effect just the broad level of infections across the U.S., in particular, ended up postponing or delaying a lot of procedures in the dental space. And if you want to back 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 terms of driving efficiencies through lean and continuous improvement that's going to take us some time to bring out and make the business a little more efficient in terms of how they serve their customers. But other than that, it's on a steady track of recovery in terms of demand barring what we saw the first couple of months of the calendar year.

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.

4%, that's like a pro forma growth rate for the business.

Correct.

Okay. And if I can do 1 more, the comments on R&D are interesting. Obviously, STERIS is not overly reliant on any single product. And so I don't wish to over state the importance of any single product category with this question, but I have noticed that you have recently launched relatively recently. I think this year, late last single-use reader scope, and it's always a topic that seems to come up from time to time.

And 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.

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 from key opinion leaders, and it's really 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 fast understanding and engineering that we have around scope design from a repair perspective. 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 a more realistic launch, we'll be able to provide some update and information on it. At this point, it's just too early days for us to discuss it.

And the next question will come from Dave Windley from Jefferies.

Most of follow-ups. You've commented on recovery in volumes broadly and thinking predominantly health care and AST. I'm wondering if you could comment on whether you see the primary drivers of those volumes being kind of recovery of pent-up demand, as you've mentioned, how much might be market share gains and any other contributors to that?

Well, I mean, I think in terms of procedure volume, that's pretty straightforward. As 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, has 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.

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's 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 of share 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 health care and life sciences over the years and also in significant capacity expansion investments in AST.

And consequently, I think we're doing a little bit better than market in those spaces.

Great. And follow-up different topic around capital structure. You mentioned leverage, I think, was 2.4x, 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 -- I'm kind of getting that how much floating interest rate debt do you have? And is the rising interest rate environment encouraging you to pay off more of that more quickly?

Yes. So I would say that in general, as we are anticipating about $675 million 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, next would be to continue to invest in ourselves, and we're continuing to do that. We've got about anticipating about $335 million of CapEx, which is almost $50 million higher compared to the prior year.

And we -- a lot of that CapEx is going to be continued directed into our AST segment as we continue to expand our facilities and our opportunities in that segment. Third would be looking towards M&A. We've done over 50 transactions in the last 10 years or so.

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&A path will 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 million 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.

Dave, just I think you asked about that, about 1/4 of our debt is floating rate debt.

(Operator Instructions) The next question is a follow-up from Chris Cooley from Stephens.

Just 2 quick follow-ups for me, if I may. Could you speak to the margin profile in the digital business? I'm just trying to get a better sense of we saw sequential progression downward throughout fiscal '22. How much of that decline in the fourth 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? And then just a quick follow-up.

I was 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.

Dan, I'll take the dental one, and I'll give you the AST one, if that's okay. Sounds good. On the margin profile of Dental, Chris, you are correct. We have seen a degradation in our EBIT margins in that business. In the first quarter 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.

Understood. .

Yes. And Chris, on the AST question, we're in the process of a pretty significant build-out across our network. And actually across multiple technologies, 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 has 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. The earliest will be late, very late this fiscal year, most likely in Illinois and then followed by either California or Chester, New York.

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.

Thanks, everybody, for taking the time to join us this morning. We look forward to catching up with many of you live in the coming days.

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