STERIS Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 11, 2023

There are 8 speakers on the call.

Operator

Good morning, and welcome to the STERIS Plc 4th Quarter 2023 Earnings Conference Call. All participants will be in listen only mode. After today's presentation, Please note, this event is being recorded. I would now like to turn the conference over to Julie Winter, Investor Relations. Please go ahead.

Speaker 1

Thank you, Chad, and good morning, everyone. As usual, speaking on our call this morning will be Mike Tucic, our Senior Vice President and CFO And Dan Crestio, our President and CEO, and 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 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.

Speaker 1

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. Company does not undertake to update or revise any forward looking statements as a result of new information or future events or developments. Verus' 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 Additional information regarding these measures, including definitions, is available in our release as well as reconciliations between GAAP and non GAAP 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.

Speaker 2

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 Q4 performance. Following my review, Dan will comment on the full year fiscal 2023 and talk about our outlook for fiscal 2024. For the quarter, constant currency organic revenue increased 16%, driven by volume as well as 3 30 basis points of price. As anticipated, gross margin for the quarter decreased 2 40 basis points compared with the prior year to 43.1% As pricing and currency were more than offset by unfavorable mix and approximately $15,000,000 in excess material and labor inflation, We incurred approximately $90,000,000 in higher material and labor costs during fiscal 2023.

Speaker 2

We achieved approximately $10,000,000 of cost synergies from the integration of Cantel Medical in the 4th quarter, bringing our full year total to just over $55,000,000 We are proud of the work our folks did to integrate Cantel Medical into STERIS, overachieving our projected total cost synergies ahead of schedule. We have substantially completed the integration process and going forward, we will no longer be tracking and reporting cost synergies from Cantel. EBIT margin increased 20 basis points to 23.8 percent of revenue compared with the Q4 last year. This reflects a reduction in SG and A as a percentage of revenue, somewhat offset by the gross margin pressures I mentioned earlier. The adjusted tax rate in the quarter was 23.6%.

Speaker 2

Net income in the quarter was 229,200,000 And earnings were $2.30 per diluted share. Capital expenditures for fiscal 2023 exceeded our plan and totaled $362,000,000 while depreciation and amortization totaled $553,000,000 Our capital expenditures Spending was higher than anticipated, primarily driven by the timing of investments in our AST segment. Total debt remains just over $3,000,000,000 reflecting borrowings to fund a few small acquisitions during the year and opportunistic share repurchases. We remained active buying back stock in the Q4 and in total repurchased 1,600,000 shares in fiscal 2023 For a total spend of $295,000,000 As we anticipated last week or as announced last week, Our Board has authorized a new repurchase program for up to $500,000,000 in buybacks. For fiscal 2024, we would anticipate returning to our normal cadence of repurchasing shares only to offset dilution.

Speaker 2

Total debt to EBITDA at the end of the fiscal year is just under 2.3x gross leverage. Free cash flow for fiscal 2023 was $410,000,000 Free cash flow was limited by higher than planned capital spending and pressure on working capital, in particular for inventory and receivables. With that, I will turn the call over to Dan for his remarks.

Speaker 3

Thanks, Mike, and good morning, everyone. Thank you for taking the time to participate in our Q4 and full year call. I will cover a few of the highlights of the year and then address our outlook for fiscal 2024. As you heard from Mike, we ended the year strong and grew revenue 9% on a constant currency organic basis This is impressive performance, in particular given the macro challenges we faced all year. We are cautiously optimistic the supply chain challenges have eased in a meaningful way and surgical procedure rates are improving.

Speaker 3

Our Q4 and full year results are reflective of that. At the business level, our Healthcare segment revenue ramped up throughout the year, Culminating in 11% constant currency organic growth for the year with very strong performance in the 4th quarter. Healthcare Capital Equipment grew 15% for the year on top of double digit growth last year. The team did a great job working through the WIP inventory and shipped $50,000,000 more capital equipment in the 4th quarter than we did in 3rd. Having the components we needed to get those products out to our customers was essential and it was a huge lift by our supply chain and manufacturing teams.

Speaker 3

While we still have pockets that are challenging, we are feeling much better about the availability and access to components for our capital equipment heading into fiscal 2024. In addition, our backlog continues to hover around 500,000,000 Despite the strong shipments during the quarter, dollars 500,000,000 is a very solid place to start the new fiscal year. Of note, our orders have shifted again towards large projects, which represented 50% of the capital equipment orders in the 4th quarter. Remember that large project orders tend to have longer lead times. Healthcare consumables also finished the year strong As we saw restocking of products as surgical procedures continued to increase sequentially.

Speaker 3

For the year, consumables revenue grew 5%, about in line with our long term expectations, although revenue was a bit lumpier from a quarter To quarter perspective than we would normally anticipate. Our healthcare service revenue finished strong, growing 8% for the year with solid growth across all the business aspects. Our AST segment grew 12% on a constant currency organic basis The year despite a reduction in demand for single use bioprocessing disposables. As healthcare procedures continue to rebound, The underlying demand for our products from core customers in medtech remain very strong. As mentioned last quarter, About 10% of the AST business is comprised of bioprocessing customers, which slowed for the first time during our Q3.

Speaker 3

That trend continued into the Q4, where once again we saw a decline in revenue of about 5,000,000 We believe the trough will come in the first half of our new fiscal year. And while we would expect to return to sequential growth in the second half, we do not expect to return to year over year growth until fiscal 2025. Our customers in that space have made significant investments to expand their manufacturing capacity for the long term growth. And we have every belief that, that growth will return once we work through the short term destocking. Turning to life sciences.

Speaker 3

Constant currency organic revenue grew 5% for the year with a strong finish in the 4th quarter Despite the reduction in bioprocessing and vaccine demand, as anticipated, the $10,000,000 in capital equipment that we couldn't ship The 3rd quarter came through in 4th, contributing to a record quarter of capital shipments. Consumables Also finished strong as we work through supply chain challenges, including more normalized shipping to Asia Pacific, And we were able to make progress towards more normal delivery times. Service grew mid single digits for the year With solid performance and equipment maintenance and installation of new capital equipment, backlog is holding just over $100,000,000 and that Dental was about flat on a constant currency organic basis for the year. Procedure volumes remain at approximately 95% of pre COVID levels due to the broader economic pressures impacting consumer spending. Based on market data, STERIS is performing better than market and benefiting from pricing and modest share gains.

Speaker 3

Turning back to the P and L. Even with favorable pricing, gross margins were down 180 basis points for the year as our cost increased at a rate faster than we could recoup. We did a nice job managing SG and A on the year And improved EBIT margin by 10 basis points in the face of the gross margin declines. Unfortunately, part of that was due to lower incentive compensation for our people, which we'll be working hard to get back in fiscal 2024. Interest and taxes were a bit of a headwind to bottom line growth, But we finished fiscal 2023 at $8.20 and adjusted earnings per diluted share, an increase of 4% from fiscal 2022.

Speaker 3

While that is certainly lower than our standard earnings performance, our 5 year CAGR for adjusted EPS is still in a press of 15%. As I said in the beginning of the call, we feel optimistic heading into fiscal 2024. Our strong 4th quarter allowed us to level out our performance between We also saw nice signs of improvement, which began in the Q3 and Continued to improve sequentially, leaving us optimistic that we have a few tailwinds in fiscal 2024. In particular, We anticipate continued recovery of healthcare procedures and easing of supply chain issues as well as foreign currency leveling out. For fiscal 2024, total revenue is anticipated to grow 7% to 8% That includes about 200 basis points and favorable pricing.

Speaker 3

Gross margins are expected to improve modestly as some of the headwinds faced in fiscal 2023 abate. EBIT margins are anticipated to be about flat As we absorb approximately $40,000,000 from incentive compensation year over year and cost increases above and beyond normal inflation for material and labor About $30,000,000 Interest and taxes will be a bit of a headwind, some of which will be offset by a reduced share count, reflecting the additional purchases made during fiscal 2023. Factoring in all of those moving pieces, our outlook For adjusted earnings per diluted share for fiscal 2024 is $8.55 to $8.75 To assist you in your modeling, we do anticipate that our revenue and earnings will be weighted towards the second year second half of the year. In the first half, we anticipate continued impact from a reduction in bioprocessing demand resulting in difficult comparisons within That will impact our growth and profitability. For both revenue and EPS, we would expect the split to be 45 in the first half and 55 in the second half.

Speaker 3

As we look at our Healthcare Capital Equipment, backlog remains strong and we believe in fiscal 2024, We will return to a normal cadence of shipments, which generally start lighter in the Q1 and then build throughout the year. Our plan assumes we get back to normal lead times by the end of the fiscal year. And while we do not provide quarterly guidance, I would note that the anticipated cadence of capital equipment revenue combined with the significantly higher interest expense And tough comparisons in AST with bioprocessing will limit our Q1 earnings growth potential. That said, the tide is turning. We are feeling good about the direction where we are heading and the outlook we have provided for fiscal 2024.

Speaker 3

As we have said before, our continued long term goal is to grow revenue mid to high single digits and leverage that growth to deliver double digit growth in earnings. We strive to achieve this while also generating solid free cash flow, continuing to reduce our debt levels and grow our dividend. Before we open for Q and A, I do want to make a few comments on the draft rules issued by the EPA last month. As you all know, over the past few years, we have made significant investments consistent with our practice of continuous improvement within our facilities. Our sustainable EO program and total permanent enclosure investments position us very well to comply with many of the draft requirements.

Speaker 3

We believe the EPA understands the weight of this regulation and its impact on the security of the vital U. S. Sterile device supply chain, And we are confident there will be a reasonable outcome for the final rules. Behind the scenes, we are partnering with our industry association in terms of our Thank you. And with that, I'll turn the call back over to Julie to open it up for Q and A.

Speaker 3

Julie?

Speaker 1

Thanks, Mike and Dan, for your comments. Chad, if you could give the instructions for Q and A, we'll get started.

Operator

Certainly, we will now begin our question and answer session. And the first question will come from Matthew Mishan from KeyBanc. Please go ahead.

Speaker 4

Hey, good morning and thank you for taking the questions. Dan, could you talk and or Mike, Can you talk a little bit more about the implied operating margin assumption of kind of flat kind of year over year Outside of incentive comp, is there what else is what are the other major moving pieces there?

Speaker 2

Yes. The next biggest piece is labor costs have gone up across the board as The people we hired last year are more costly, so that's definitely going to hurt us a bit. We also are going to return more to Somewhat pre COVID levels in our spending, especially around travel, and then also FX is actually going to be a negative to us And the operating expense, but by the time it gets to the bottom line, it will be about neutral to us.

Speaker 4

Okay. And then I'm having a little bit of problems modeling flat Based upon some of the assumptions below the line, what are can you more explicitly call out the assumptions for share count and for interest expense in 2024.

Speaker 2

Yes. Share count will just be just over $99,000,000 Interest expense and other will be approximately about $10,000,000 to $15,000,000 headwind in total. Most of that, as Dan alluded to in his comments, most of that interest expense headwind It is going to hit us in the first half. Majority is going to actually hit us in the Q1, because that's when we started seeing rates significantly rise was in the second quarter and For sure in the second half.

Speaker 4

I'll jump back in the queue. Thank you.

Speaker 5

You're welcome, Matt.

Operator

And the next question is from Dave Turkaly from JMP Securities. Please go ahead.

Speaker 5

Hey, great. Good morning, guys, and Congrats on a strong wrap to the fiscal year. I was wondering maybe if we could get some thoughts given how This quarter even played out divisionally in terms of how you're getting into the numbers in terms of the growth for fiscal 2024. So I'm sure healthcare is not growing 20%. Even if we're looking at sort of ranking them, it sounds like AST maybe some tough comps, so maybe it's Healthcare, Life Science, AST, but any color around sort of secular growth rates or what you think for those businesses to start this year?

Speaker 2

Yes, Dave. So if you look at our total company, right, so we would say that on average, Most of our businesses other than AST grow mid to high single digits. AST, obviously, right around double digits, 10% grower. This year that is the case with healthcare potentially outpacing their normal growth, but life sciences Would be in that same range and then dental would be single digit growth in total.

Speaker 5

Got it. And then I wanted to just ask a follow-up on free cash flow. We had a bunch of companies reports, I've been Jumping back and forth, but I think you guided to $700,000,000 this year and I think the comp was $409,000,000 So I'd just love to get your thoughts, Mike, on What exactly is happening there?

Speaker 2

Yes. This year, we were under significant pressure from a free cash flow standpoint. Both Our receivables increased because just the timing of the revenue, a big bulk of our revenue was in Q4. So we are unable to collect. So that will Push into FY 2024.

Speaker 2

Our inventory, as we've been talking about all year, has been high. So we've got We've got to take that down. So we're anticipating to take that down in FY 2024. And then also in FY 2020, capital expenditures were Higher than we anticipated originally. So the combination of all three really put pressure on FY 2023 free cash flow.

Speaker 2

As we look into 2024, The big change where we're going to get a nice impact is going to be lower inventory, our ability To collect those receivables and then just growing net income in total, will get us to about $700,000,000 in total free cash flow.

Speaker 5

Great. Thank you. You're welcome, Dave.

Operator

And the next question will be from Mike Matson from Needham and Please go ahead.

Speaker 6

Yes, thanks. I wanted to ask one on the EPA requirements for ethylene oxide. The comments that you made were, I guess, kind of vague. I guess, the way I would interpret them and correct me if this is wrong is that You are expecting some sort of changes in the final rule. I don't know if you're willing to comment on what Areas you think maybe need to be changed.

Speaker 6

I know AdvoMed kind of called out the 18 month timing and Some of the employee safety requirements in there. If the final rule ended up looking like the proposed rule, Can you comment on whether or not you would meet those standards and whether or not there'd be incremental costs to get there if you don't?

Speaker 3

Yes. I think there's still a lot that's got to get worked out in the final definition of the rule. And my speculation is it probably gets extended in terms of I would tell you that from a knee shop perspective, we're really Confident where we sit in terms of our ability to meet as written and what could possibly be modified. As it relates to FIFRA, I think we got a little more gas over that as we are no one in the industry right now are capable of meeting some of the stated exposure level standards. So I think that's got to get sorted out and I think it will through the process.

Speaker 6

Okay. Thank you. And then just on the dental business, so it was down in 24, most down most quarters at least. You said 95% of pre COVID levels, but I would assume if you stayed at the 95% in fiscal 2024, then you should be able to get back to flat or even maybe some modest growth there. Is that a reasonable assumption?

Speaker 3

That's correct. Yes, that Assuming that it sustains at that level and some of the modest level of pricing adjustments we've been able to put through to that business, we believe that we can grow the revenue in the low single digits range.

Speaker 6

Okay, thanks. And then just in terms of The share repurchase, so you stepped in to buy back some stock in 2023. You said going forward with the new authorization, you're not planning to do anything other than just So dilution, but I guess what drove the decision to buy back stock in 2023 rather than Prepaid debt, was it just opportunistic? I know the stock fell on some of the ethylene oxide concerns and whatnot.

Speaker 3

Yes. It was just exactly that, Mike. It was just opportunistic based on where the share price moved down, Largely on some of the EO litigation issues and things that the industry are facing. So we saw it as a good opportunity to invest in our Astera stock.

Speaker 6

Okay, got it. Thank you. Yes.

Operator

And the next question is from Jacob Johnson Stephens, please go ahead.

Speaker 7

Good morning. This is Mac on for Jacob. Just a couple of quick ones for me. And to follow-up on the EPA question earlier, can you comment on some of the initiatives that you already have put in place? And do you think these give you a competitive advantage as compared to some of your competitors who will have to install those in the future?

Speaker 3

Well, what I'll tell you is some of our practices, I mean, we've had our employees in what I would categorize as hot zones Wearing full PPE, SCBA is self contained breathing apparatus for over 10 years in our facilities. So I think we're already ahead of Most of industry in terms of safeguarding our employees. We've installed on all of our outbound warehouses, Abatement systems to scrub any fugitive emissions that's coming off product post aeration process, Those are completely installed operational in the U. S. Facilities.

Speaker 3

A number of other things in terms of just basic engineering design around our And a number of different engineering controls that we have in place, as it relates to the design of the facility. In addition to that, We've been working hard with our customers and also pushing industry very hard to reduce the initial concentrations that are used in cycles. And we've been very effective in moving many of the higher concentration cycles that are touching 650, 700 milligrams per liter Down closer to 300 milligrams per liter. So it's a much lower input in, which much makes handling product, especially post processing, much safer.

Speaker 7

Thanks for the color. And then also, can you touch a little bit on your capital allocation priorities in terms of the Buyback that you previously announced and also M and A for the year?

Speaker 2

Yes. So our capital allocation priorities have been the same for more than a decade, Increased dividends off the top, invest ourselves, so continue to spend money from a capital expenditure standpoint, especially growing and investing in our AST expansions, then M and A and then finally, repurchases, typically just to offset Dilution. So those 4 categories have remained. The other one that we from time to time we'll put in there is Focus on paying down debt as we're almost 2 years into the Cantel acquisition That is being a little bit less focused on as our debt levels now are in what we'll call very reasonable ranges at 2.3 times levered. And as Mike as you heard Mike asked the question earlier about the opportunistic share repurchases, that has not happened very often as a But again, we felt that it was advantageous to us to do some of that opportunistically in the 3rd Q4 of this fiscal year.

Speaker 3

Thank you for the color.

Operator

And our next question is from Michael Pollack from Wolfe Research. Please go ahead.

Speaker 7

Good morning. Thank you for taking the questions. 2 parter on AST. I want to understand the margin trend there, Kind of pushes and pulls, it was kind of a steady glide lower throughout the last fiscal. Where does it bottom and what's a good input for segment margin in fiscal 2024?

Speaker 7

And then related in AST, You've been very clear about destock in bioprocess. I'm wondering what your feel for Potentially a similar dynamic is in kind of your core medical device customer base. The world's kind of emerging from COVID, Procedures seem to be back. A lot of the interventional medical device companies are holding way more inventory than they used to. Is there any kind of risk of a little bit of a destock cycle there for you Or not, how are you thinking about that in fiscal 2024?

Speaker 3

Yes. I'll address the latter first in terms of recovery in medtech. I don't think so. Really what we're seeing in terms of our medtech customers is they're really rebuilding the inventories that they have and they're still In many cases hand to mouth in terms of being able to deliver for hospitals right now. So it's not as if they're flush with inventory across the system.

Speaker 3

And so I would assume we'll see some continuing build of inventory of anticipation of surgeries continuing at the rate they're at As well as there's a lot of pent up demand that's got to be worked off over the next coming months or year or so. So I don't think there's a lot of risk In terms of any type of inventory pullback from a MedTech perspective, I think it's pretty robust. In terms of the other question around the AST margins, I mean, the short answer is, is there were inflationary pressures in particularly on energy and labor. And the labor is baked in, is what I would say, and we can leverage that over scale as we get volume coming through. It tends to help a bit.

Speaker 3

Energy, my crystal ball doesn't work when it comes to electricity pricing in Europe anymore. So It is what it is. It's high right now. It was high this winter. In theory, it should come down some over the coming months or year, but your guess

Speaker 7

Helpful. And then maybe just request for a feel for Hospital spending patterns on capital equipment kind of you made comments about good mix New large projects in your new orders. What's your crystal ball say about how new spend patterns go in fiscal 2024?

Speaker 3

It's interesting and we're pleasantly surprised every month when we see the orders coming in strongly, very strong as we did in Q4. And our backlog Sitting at $500,000,000 in healthcare, which is either at or near all time record highs basically. You got to think of it this way. Most of what we sell in terms of capital is necessary to facilitate volume of procedures And recovery of volume of procedures through the hospital, I mean the sterile processing department equipment we sell in terms of washers and sterilizers and sinks and everything like that, You got to think of it more like a utility and it's not a nice to have. It's something you need to have in order to accomplish the growth For patients in terms of procedure volumes.

Speaker 3

So we've been somewhat immune to the financial woes of the healthcare sector, I would say, in terms of hospital And I believe that will continue in terms of the long term. I think over time and I don't know if that's 6 months or a year from now, you're probably going to see some de escalation in terms of just infrastructure build out that we're seeing right now. And one would also think that as things tighten a bit in terms of capital, it would generally has the Impact of slowing down the replacement business a bit, which we tend to pick up then on the service side. But as of right now, We seem to be doing pretty well in terms of order intake.

Speaker 7

Appreciate that. Thank you.

Operator

The next question is from Jason Bednar from Piper Sandler. Please go ahead.

Speaker 7

Hey, good morning, guys. Thanks for taking the questions here. A bit of a related follow-up there on Pollard's question, I'll focus on the place where margins have actually gone in the opposite direction. Healthcare margins improved sequentially now, I think 5 quarters in a row. Can you talk about your comfort level on the year end or full year margin levels in that segment as we look forward to fiscal 2024 again in the context of your overall guide as well?

Speaker 2

Yes. We should continue to do fairly well and increase margins in Healthcare. We anticipate that we will continue to get price within Healthcare. We also anticipate that some of the pressures Surrounding inflation, material and labor cost ease, we should also be able to get some productivity increases In our Healthcare business, just because we had to touch the products so many times last year With parts availability that should help us improve. So I would anticipate that the margins in Healthcare get slightly better, EBIT margins in

Speaker 7

Okay. Thanks, Mike. That's helpful. And then maybe another follow-up, but bigger picture on Dental. You've had that asset now for a couple of years.

Speaker 7

I know you've gotten this question in the past, but maybe just to revisit it. Can you update us on your thoughts regarding that category, but mostly your commitment to that end market? On one hand, it's a good category for roll ups. It's fragmented. There are a lot of private companies out there that aren't runs in a super efficient way.

Speaker 7

So that's an opportunity, but it's also a drag on growth and margins for the overall franchise. And it's tough to forecast, I Strong mid single digit growth for that market even longer term. So maybe you disagree there, but again, just love your updated view on, just as we head into year 3, STERIS commitment and participate in that pedal market?

Speaker 3

Yes, we remain committed. We need to see it through in terms of recovery. We didn't anticipate last year sliding into an economic recession that was going to thwart the progress made in terms Procedure recovery that we're seeing in dental and now it's become an economic issue. So I think we need to see that play out over this fiscal year and see how the business performs. There's still I would reiterate, there's still a lot of opportunity for operational improvement, deliver improvement in the business.

Speaker 3

And that's something that STERIS has a long history as good operators of being able to really drive improvements with the business. It'd be nice to see the volume resume. It makes all those good things that we're doing much more visible in terms of bottom line performance when the volume comes back.

Speaker 7

All right, helpful. Thank you.

Operator

Thank you. And our next question is a follow-up from Michael Pollard from Wolfe Research. Please go ahead.

Speaker 3

Thank you for taking the follow-up.

Speaker 7

I was just looking at a lot of great data disclosed in terms The reporting, I could explain sequentially the Healthcare Consumables line, notable step up there, clearly levered to Procedure and throughput. The Healthcare Services line stepped up notably sequentially, and I struggle a little bit Kind of tying that to an end market development. So kind of what happened there Q over Q? It was a double digit Increase?

Speaker 2

Yes, Mike, a big portion of that was we actually had parts availability. So we're actually able to get parts into our customers' hands and fix Install that in the Q4, so we generated revenue there. Those are the 2 main drivers of that business for Q4 improvement.

Speaker 7

Thank you.

Speaker 5

You're welcome.

Operator

And ladies and gentlemen, this concludes our question and answer session. I would like

Speaker 1

Thanks everybody for taking the time to join us and look forward to seeing Many of you on the road this summer.

Operator

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

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