STERIS plc (STE) Q4 2022 Earnings Report, Transcript and Summary

Good day and welcome to the Steris PLC Fourth Quarter 2022 Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [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, Ted, and good morning, everyone. As usual, speaking on today's call will be Mike Tokich, our Senior Vice President and CFO and Dan Carestio, 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, re-transmission or rebroadcast of this call without the expressed 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 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 of organic revenue growth, and free cash flow will be [Indiscernible]. 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 a 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 a 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 a 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 FY2023, 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 non-operating expenses net is anticipated to be about $95 million. In addition, we expect 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.

Thanks, Mike, and good morning, everyone. 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 two of a global pandemic, but we also completed the acquisition of Cantel, while integrating Key Surgical, and successfully transitioned 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. 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 out-performance 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 million 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 million to our fiscal 2022, results. 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 two additional months of the Cantel acquisition, offset by the impact of the Renal Care divestiture, as well as approximately $30 million in unfavorable foreign currency. Excluding all that, we anticipate constant currency organic revenue growth of approximately 11%. Importantly, this outlook assumes that the procedure volumes will normalize in the U.S. and that we do not experience any significant wave of disruption from COVID. 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 costs year-over-year. For FY2023, we expect an incremental $70 million in extraordinary supply chain and labor inflation costs, above the $45 million we occurred in FY2022. This is in addition to our normal low single-digit annual inflation amounts, always included in our outlook, which we will work to overcome every year. In addition to the anticipated headwinds from supply chain and inflation, our FY2023, operating expenses will be higher as we get back to spending on travel, sales, and marketing, and other expenses. R&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 million from the FY2022 levels. By the end of FY2023, we will be approaching $100 million in total cost synergies achieved. Taking into consideration all of the puts and takes, we expect to show modest operating margin growth in FY2023. 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 FY2022. 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. 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 three 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&A.

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

Certainly. [Operator Instructions] At this time, we will pause momentarily to assemble our roster. And the first question will be from Chris Cooley from Stephens. Please go ahead.

Good morning. Thanks for taking the questions and congratulations on a stellar year there in fiscal 2022. Just two for me, if I may, here this morning, first, just thinking about 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 -- [Indiscernible] there’s some different aspects to the business. Just would appreciate it if you can maybe call out where you're seeing strength, where you need to see some improvement just from operationally and from a divisional perspective? So, we can think about that in terms of the drivers, both of growth and then as a result margin as we go through the year? Then I've got a quick follow-up. Thanks.

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 way to go. And I think that the real governor on the recovery of those rates is going to be staffing and the challenges that -- 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 recovery of more and more devices coming through AST in particular that are more highly elective, high-value type devices. So orthospine, things like that and of that nature. So as those procedures begin to recover and then start working off what's been a couple year backlog of pent-up demand, we're seeing higher growth opportunities than we've seen maybe in the past. In addition to that, were 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.

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 curious, you're talking about a return to normalcy when I think about SG&A more broadly higher R&D as well, just directionally, how much of this is a return to normal? How much of this is incremental investment that you're making for the sustainability of the growth of the business? Or was the business maybe under-invested in over the course of the last 18 to 24 months? Just trying to get a better feel for what structurally we should be thinking about longer-term just from an expense rate? Thank you.

Yeah. 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 under-invested by any means, and as Dan said in his prepared remarks, we've had our first sales meeting in three years. So, you can imagine the expense of that compared to the last two 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 though, is in R&D. R&D we anticipate growing by double-digits in fiscal 2023, 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 two, a step-wise change that we are continuing to invest for the long term. Not that we were under-invested by any means. We just think there's a lot more opportunity that we can bring forth, especially with the acquisition of Cantel.

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

Thanks Chris.

Thanks Chris.

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

Yes. Thanks for taking my question. I guess I'll start with just the first quarter in '23. You've got a bit of a tougher organic comp, I think. I didn't hear any directional commentary around where you expect the revenue. Is it safe to assume you're comfortable where consensus was modeling things? I'd assume it's a lower -- you're expecting lower organic growth in the first quarter than the remainder of the fiscal year.

This is Mike talking to you. 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 or second-half, we're about 45% percent 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, and nor have we in several years.

And just to clarify that's [Indiscernible] earnings.

Yes. You're correct.

Okay. Got it. That's helpful. All right. And then You mentioned that there are some trends that in the industry they're [Indiscernible] STERIS, I just wonder if you could just talk a little bit more about that. I'd assume one of them is the trend towards ASTs, where the ASTs have to get outfitted with cleaning and sterilization equipment and whatnot, but maybe just talk about some of those industry-wide trends.

Yes, that is one clearly, this -- 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 with our portfolio products, in particular with SPD and also in -- 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. Yeah. The other tailwind that we're getting is, as I mentioned before, is just general procedural recovery which drives our consumables, that 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 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 backlogs in Life Sciences that's going to flush through this year as it relates to some of the expansions that -- in 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 our [Indiscernible] as well.

Okay. Got it.

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

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 billion of cash flow from operating activities in my model. I mean, I'm coming in higher than that, but I -- the only way I could get there is assuming your working capital was up a fair bit. I mean, is that a reasonable assumption and that maybe you’re stocking up on inventory things, but pre -buying stuff because of the supply chain issues, we've heard that from other companies.

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 shipped 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 contingencies in supply chain continuity built into our inventory levels right now.

Okay, got it. Thank you.

You're welcome.

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

Hey, good morning. I 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 in came in a little late in the fourth quarter. Did some of the backlog shifts from the fourth quarter into FY 23.

Yeah, 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 adds a lot of [Indiscernible] As you compare the 11% organic growth for FY23, to what is a more sustainable level of organic growth, you back out that Capital Equipment. I guess, price is probably not 200 basis points moving forward. What do you -- how do you look at what is its sustainable level of organic growth compared to the 11% for '23?

Yeah, 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.

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 where that's potentially moving.

Yeah, 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, these aren't million dollars, $2 million machines. And the other point I would make is, everything we sell basically, is procedural rate-driven. And it's in, 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 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.

Thank you very much.

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

Good morning. Thank you for taking the questions. One clarification on the response to Mike Matson's question, the 45, 55, Mike Tokich, was that a comment on revenue progression 1H, 2H, or EPS?

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

There was three Mikes in my first question to you, three Mikes 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, 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 we'll be at its normalized growth. And then obviously, Dental, we still don't have a true comparison at that point in time, so.

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. How do you feel about that business? What is the work-streams and initiatives for fiscal '23 as you continue to integrated and learn that market?

Yeah. It's Dan, Mike. So yeah, 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 February time-frame. And unlike Healthcare 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 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, at this calendar year. So, we like the business, we think there's a ton of operating opportunities in terms of driving efficiencies through [Indiscernible] and continuous improvement. That's going to take us some time to wring 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 in the calendar year.

And Mike, just to add to that a little bit. 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 -

Correct.

- growth rate for the business? Okay.

Yeah.

And if I can do one more, the comments in R&D are interesting. Obviously, STERIS is not overly reliant on any single product, and so I don't wish to overstate 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 or late last. The single-use Ureteroscope, and I saw as a topic that seems to come up from time-to-time. And I'd just be curious about your efforts there. And if this launches an appetizer to some more products and that single-use scope category overtime. Thank you so much for taking the questions.

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 early, early days at this point. And we'll see how that goes and how it progressive 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, 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 information on it. At this point, it's just too early days for us to discuss it.

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

Thanks for taking my questions, most of them follow-ups. You've commented on the recovery in volumes broadly and picking predominantly Healthcare and AST, but I'm wondering if you could comment on whether you see those -- the primary drivers of those volumes being recovery, demand as you've mentioned, how much might be market share gains and any other contributors to that?

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 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. 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 overall growth rate, I do believe we're taking a bit of share across the majority of the business 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 in AST. And consequently, I think we're doing a little bit better than market in those spaces.

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 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. 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 those 16 years in a row. Next would be, to continue to invest in ourselves and we're continuing to do that. We're anticipating about $335 million of CapEx, which is almost $50 million higher compared to the prior year. And 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 share repurchase standpoint, just to offset dilution. And we have that built into our plan for this year, we did do about $25 million dollars of share repurchases in Q4. But we had a hiatus on share repurchases for the last 18 months or two years. So, from a prioritization standpoint, that is how we operate and how we have continued to operate over the last several years.

Thank you.

Dave. Just -- I think you've asked about that about a quarter of our debt is floating-rate debt.

Okay. Thanks.

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

Thanks for taking the follow-up. Just two quick follow-ups for me, if I may. Could you speak to the margin profile in the Dental business? Just trying to get a better sense of we saw a 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 response to a prior question. But just when we should maybe start to expect stabilization there or maybe a lift better. And then it's just a quick follow-up. Bit curious if you could discuss or provide any additional color on 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. Thank you so much.

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

Yes, it 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 have definitely had a negative impact of 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.

Dan 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 EEO 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. In particular, in the US, there's three 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.

Thank you.

Ladies and gentlemen. This concludes our question-and-answer session. I would like to turn the Conference back up to Julie Winter for any closing remarks.

Thanks everybody, for taking the time to join us this morning and 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.