Q4 2023 STERIS plc Earnings Call
Good morning, and welcome to the terrorists plc fourth quarter 2023 earnings conference call.
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I would now like to turn the conference over to Julie Winter Investor Relations. Please go ahead.
Thank you Chad and good morning, everyone.
As usual speaking on our call. This morning will be my ticket.
Senior Vice President and CFO , and Dan Crusty O, our president and CEO and I do have a first few words of caution before we open for cabinets.
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Some of the statements made during this review are or maybe 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 cirrhosis 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.
That's a 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 our release as well as 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. This is once again my pleasure to be with you. This morning to review the highlights of our fourth quarter performance.
Following my review, Dan will comment on the full year fiscal 'twenty, three and talk about our outlook for fiscal 'twenty four.
For the quarter constant currency organic revenue increased 16% driven by volume as well as 330 basis points of price.
As anticipated gross margin for the quarter decreased 240 basis points compared with the prior year to 43, 1% as pricing and currency were more than offset by unfavorable mix and approximately $15 million of excess material and labor inflation, we incurred approximately 90 million.
And higher material and labor costs during fiscal 2023.
We achieved approximately $10 million of cost synergies from the integration of cantel medical in the fourth quarter, bringing our full year total to just over $55 million.
We are proud of the work our folks did to integrate cantel medical into stairs over achieving 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 cantor.
EBIT margin increased 20 basis points to 23, 8% of revenue compared with the fourth quarter last year. This reflects a reduction in SG&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%.
Net income in the quarter was $229 2 million and earnings were $2.30 per diluted share.
Capital expenditures for fiscal 2023 exceeded our plan and totaled $362 million, while depreciation and amortization totaled $553 million, our capital expenditures spending was higher than anticipated primarily driven by the timing of investments in our ASP.
Segment.
Total debt remains just over $3 billion, reflecting borrowings to fund a few small acquisitions during the year and opportunistic share repurchases.
We remained active buying back stock in the fourth quarter and a total repurchased one 6 million shares in fiscal 2023 for a total spend of $295 million as we anticipated last week.
Whereas announced last week, our board has authorized a new repurchase program for up to $500 million in buybacks.
For fiscal 2024, we would anticipate returning to our normal cadence of repurchasing shares only to offset dilution.
Total debt to EBITDA.
At the end of the fiscal year is just under 2.3 times gross leverage.
Free cash flow for fiscal 2023 was $410 million free.
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.
Thanks, Mike and good morning, everyone. Thank you for taking the time to participate in our fourth quarter and full year call.
I'll 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 in fiscal 2023. This.
This is impressive performance in particular, given the macro challenges we faced all year.
We're cautiously optimistic the supply chain challenges have eased in a meaningful way and surgical procedure rates are improving.
Our fourth quarter and full year results are reflective of that.
At the business level, our health care segment revenue ramped up throughout the year.
Culminating an 11% constant currency organic growth for the year with very strong performance in the fourth 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 whip inventory and shipped 50 million more capital equipment in the fourth quarter than we did in the third.
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.
Well, we still have pockets that are challenging we're 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 million despite the strong shipments during the quarter.
$500 million 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 fourth quarter remember that large project orders tend to have longer lead times.
Healthcare consumable also finished the year strong as we saw restrike restocking of products or surgical procedures continued to increase sequentially.
For the year consumables revenue grew 5% about in line with our long term expectations, although revenue was a bit lumpier from quarter to quarter perspective than we would normally anticipate.
Our health care service revenue finished strong growing 8% for the year with solid growth across all the business aspects.
Our S. T segment grew 12% on a constant currency organic basis for the year. Despite a reduction in demand for single use bio processing disposables.
As health care procedures continued to rebound the underlying demand for our products from core customers in med Tech remain very strong.
As mentioned last quarter about 10% of the a S. T business is comprised of bioprocess and customers, which slowed for the first time during our third quarter.
That trend continued into the fourth quarter, where once again once again, we saw a decline in revenue of about $5 million.
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 it 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 constant currency organic revenue grew 5% for the year with a strong finish in the fourth quarter. Despite the reduction in bio processing and vaccine demand.
As anticipated the $10 million in capital equipment that we couldn't ship in the third quarter came through in the for 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 in equipment maintenance and installation of new capital equipment.
Backlog is holding just over 100 million and that is a great place to start the new fiscal year.
Dental was about flat on a constant currency organic basis for the year procedure volumes remained at approximately 95% of pre COVID-19 levels due to the broader economic pressures impacting consumer spending base.
Based on market data stairs is performing better than market and benefiting from pricing and modest share gains.
Turning back to the P&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&A on a 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.
We'll be working hard to get back in fiscal 2024.
Interest and taxes were a bit of a headwind to bottomline growth.
We finished fiscal 2023 at $8 20 in adjusted earnings per diluted share an increase of 4% from fiscal 2022.
Well that is certainly lower than our standard earnings performance, our five year cat CAGR for adjusted EPS is still an impressive 15%.
As I said in the beginning of the call we feel optimistic heading into fiscal 'twenty 'twenty four our strong fourth quarter allowed us to level out our performance between fiscal years more than anticipated.
We also saw a nice signs of improvement, which began in the third quarter and then continued to improve sequentially, leaving us optimistic.
Domestic that we have a few tailwind in fiscal 2024.
In particular.
We anticipate continued recovery of health care procedures, and easing of supply chain issues as well as foreign foreign currency leveling out.
For fiscal 2020 for total revenue is anticipated to grow 7% to 8% with about 100 basis points and positive foreign currency impact.
Currency organic revenue is expected to grow 6% to 7%.
That includes about 200 basis points and favorable pricing.
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 absorbed approximately $40 million from incentive compensation year over year and cost increases above and beyond normal inflation for material and labor about $30 million.
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 and 55 to $8.75.
To assist you in your modeling we.
We do anticipate that our revenue and earnings will be weighted towards the second your second half of the year and.
In the first half we anticipate continued impact from a reduction in bioprocess thing demand, resulting in difficult comparisons within I S. T 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.
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 first quarter 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 a significantly higher interest expense and tough comparisons and a S. T with bio processing will limit our Q1 earnings growth potential.
That said the tide is turning we are feeling good about the direction, where we are heading in the outlook. We have provided for fiscal 2024.
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 with.
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&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 are sustainable E. O program and total permanent enclosure investments position us very well to comply with many of the draft requirements.
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.
And the scenes, we're partnering with our industry Association in terms of our restock response to the agency.
Thank you and with that I'll turn the call back over to Julie to open it up for Q&A Julien.
Thanks, Mike and Dan for your comments.
Chad if you could give the instructions for Q&A, we'll get started.
Certainly we will now begin our question and answer session to ask a question you May Press Star then one on your Touchtone phone.
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At this time, we will pause momentarily to assemble our roster.
And the first question will come from Matthew Mission from Keybanc. Please go ahead.
Hey, good morning, and thank you for taking the thank you for taking the questions Hey, Dan could you talk 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 you know what else is what are what are the other major moving pieces there.
Yeah.
Biggest piece is caught labor costs have gone up across the board as the people you hired last year are more costly. So that's definitely going to to hurt us a bit. We also are going to return more to a somewhat pre COVID-19 levels and are spending, especially around travel and that also FX is actually going.
To be a negative to us in the operating expense, but by the time it gets to the bottom line it'll be about neutral to us.
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 you know more explicitly call out the assumption for share count and for interest expense in 2024.
Share count will just be just over $99 million interest expense at other will be a proxy about a 10th of the $10 million to $15 million headwind in.
In total most of that as Dan alluded to in his comments most of that interest expense headwind is going to hit us in the first half majority is going to actually hit us in the first quarter because that's when we started seeing rates significantly rise was in the second quarter and for sure in the second half.
I'll jump back in the queue. Thank you.
Youre welcome Matt.
And the next question is from Dave <unk> from JMP Securities. Please go ahead.
Hey, great. Good morning, guys and congrats on a strong a wrap to the fiscal year.
I was wondering maybe if we could get some thoughts [laughter] given how this [laughter] this quarter, even played out a division in terms of how you're getting to the numbers in terms of the group for fiscal 'twenty, four or so I'm sure health care's knocked around 20%.
Even if we're looking at sort of ranking them it sounds like and maybe some tough comps. So maybe it's health care life sciences to EBITDA, but any color around sort of secular growth rates or what you think for those.
As you know to start this year.
Yeah.
Yeah, Dave So if you look at our total company right. So we would we would say that on average.
You know most of our businesses other than Asps grow mid to high single digits.
ASP, obviously, yeah, right around double digits, 10% grower.
This year that is the case with healthcare potentially outpacing there their normal growth, but life sciences would be in that same range and then dental would be single digit growth.
Total.
Got it.
And then I wanted to just ask a follow up on free cash flow.
We've got a bunch of companies reports.
Jumping back and forth, but I think he guided to 700 million this year and I think the comp was 409.
I just wanted to get your thoughts Mike.
What exactly is happening there yeah.
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 were unable to collect so that will push into FY 'twenty for our inventory as we've been talking about all year has been high. So we've got a we've got to take that down. So we're anticipating that take that down in FY 'twenty four and then also what FY2023.
Expenditures were higher than we anticipated originally so the combination of all three really put pressure on FY2023 free cash flow as we look into 'twenty for 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 million in total free cash flow.
Great. Thank you.
Youre welcome Dave.
And the next question will be from Mike Matson from Needham and company. Please go ahead.
Yeah. Thanks, So I wanted to ask one on the EPA requirements for ethylene oxide.
The comment you made where I guess kind of vague I guess the way I would interpret them and correct me. If this is wrong is that your you are expecting some sort of changes in the final rule as you know I I don't know if you're willing to comment on you know what areas do you think maybe need to be changed I know after that kind of called out.
18 month timing in some of the employee safety requirements and there you.
You know if the final rule ended up looking like the proposed rule.
Can you comment on you know.
Whether or not you would meet those standards.
Whether or not there'll be incremental cost to get there if you don't.
Yeah, I think there's still a lot there's gotta get worked out and the final definition of the rule and I and my speculation is it probably gets extended in terms of comment period at this point.
Oh I would tell you that from a niche up perspective were really confident where we sit in terms of our ability to meet as written and what could possibly.
Be modified.
As it relates to fit for us and I think we gave a little a little more gas over that is as we are no. One in the industry right now are capable of meeting some of the a D. A.
Stated exposure level of standards. So I think that's gotta get sorted out in and I think it will through the process.
Okay. Thank you and then just on the dental business. So it was down in 'twenty four most town in most quarters at least.
You know you said, 95% of pre Covid levels, but I would I would assume if even if it stayed at the 95 in fiscal 'twenty. Four then you should be able to get back to flat or even maybe some modest growth there or is that is that a reasonable assumption.
Correct, Yeah that is.
That is sustained at that level and some of the.
You know a modest level of pricing adjustments, we've been able to put through through that business. We believe that we can we can grow the revenue in a low single low single digit range.
Okay. Thanks, and then just in terms of the share repurchases that you stepped into it to buyback some stock in at 23, you said going forward with the new authorization, you're not planning to do anything other than just offset dilution, but I guess what drove.
Buyback stock and 23, rather than prepay debt.
Was it just opportunistic I know the stock fell and some of the ethylene oxide concerns or whatnot.
Yeah. It was just exactly that like it was just operative thomistic based on where the share price moved down.
Largely on some of the litigation issues and things that the industry are facing so we started as a good opportunity to invest in arps, there her stare stock.
Okay got it thank you yep.
And the next question is from Jacob Johnson from Stephens. Please go ahead.
Good morning. This is Matt on for Jacob just a couple of quick ones from me.
And to follow up on the EPS EPA question earlier.
Can you comment on some of the initiatives that you already have put in place and do.
Do you think these give you a competitive advantage as compared to some of your competitors too.
We'll have to install those in the future.
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 four P. P. S E. B, a self contained breathing apparatus for over 10 years and our facilities.
So I think we're already ahead of most.
Most of industry in terms of safeguarding our employees.
You know, we've we've installed on all of our outbound warehouses.
Abatement systems to scrub any fugitive emissions, that's coming off product post iteration process.
Those are completely installed operational and the U S facilities.
A number of other things in terms of just basic engineering design around our facilities, where we have complete capture of everything in the chamber rooms.
As well as sealed drum storage rooms, which are also fully abated in the event of a leak.
And in 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 600 5700 milligram.
For leader down closer to 300 milligrams per liter. So it's a much lower input in which much it makes our handling product, especially post processing much safer.
Thanks for the color and then also can you touch a little bit on your capital allocation priorities are.
In terms of the buyback that you previously announced also M&A for the year.
Yeah, So our capital allocation priorities have been the same for more than a decade.
Increased dividends off the top.
Invest in ourselves so continuing to spend money from a capital expenditure standpoint, especially growing.
And investing in our ASP expansions.
Then M&A and then finally repurchases are typically just to offset dilution. So those four categories have remade the other one that we from time to time, we'll put in there is a focus on paying down debt.
As we're almost two 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 two three times levered.
And as Mike as you heard Mike asked the question earlier about the opportunistic share repurchases that that has not happened very often as a company, but again, we felt that it was.
Advantageous to us.
Do some of that Opportunistically in the third and fourth quarter of this fiscal year.
Thank you for the color.
And our next question is from Michael Polack from Wolfe Research. Please go ahead.
Good morning, Thank you for taking the questions to partner on E. S T.
I want to understand the margin trend, there I'm kind of pushes and pulls.
It was kind of a <unk>.
You know you've been very clear about destock in bioprocess I'm wondering what your feel for for the.
Essentially a similar dynamic is in kind of your core medical device customer base.
The world is 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 you know a little bit of a destock cycle, there for you or or or.
Or not how you're thinking about that in fiscal 'twenty four.
I'll address the latter first in terms of recovery in Med Tech.
I don't think so really what we're seeing in terms of our med tech 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 it's not as if they're flush with inventory across the system and.
And so I would assume we'll see some continuing build of inventory of anticipation of surgeries continuing at the rate that they're at <unk> as well as you know there's a lot of pent up demand that's got to be worked off over the next coming months or a year or so so so I don't think theres a lot of risk in terms of.
Any type of inventory pull back from a med Tech perspective, I think it's pretty robust.
In terms of the other question around the Asti margins I mean, the short answer is as it were inflationary pressures in particular on energy and labor and you know the the labors baked in you know what I would say and we we can leverage that over scale as we get volume coming through it tends to it tends to help a bit.
Energy.
My Crystal ball doesn't work when it comes to <unk>.
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 you know your guess is as good as mine on that.
Helpful.
Then maybe just request for a feel for hospital spending patterns on you know capital equipment kind of you made.
You made comments about good mix of new large projects in your and your new orders, but what's your crystal ball say about how you know new spend patterns.
And in fiscal 'twenty four.
It's interesting in and where pleasantly surprised every month when we see the orders coming in strongly you know very strong as we did in Q4 and you know our backlogs you know sitting at $500 million and in health care, which as you know.
Either at or near all time record highs basically.
You know you you've 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 through the hospital I mean the sterile.
<unk> Department equipment, we tell in terms of washers, sterilizers and sinks and everything like that.
You got to think of it more like a utility and it's it's not a nice to have it's something you need to have in order to to accomplish the growth for for patients in terms of procedure volumes. So we've been somewhat immune to the financial lows of the health care sector I would say in terms of hospital spending.
And you know.
I believe that will continue in terms of the long term I think over time.
And I don't know if that's six months or a year from now you're probably going to see some de escalation.
And in terms of just infrastructure.
Structure build out that we're seeing right now.
And one would also think that as things tightened 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.
I appreciate that thank you.
And again, if you have a question. Please press Star then one.
The next question is from Jason Bednar from Piper Sandler. Please go ahead.
Hey, good morning, guys. Thanks for taking the questions here a bit of a related follow up there on on <unk> question.
On segment margin, but I'll focus on the place where margins have actually gone the opposite direction health care margins improved sequentially now I think five quarters in a row can you talk about your comfort level on the year end or full year margins levels margin levels in that segment as we look forward to fiscal 'twenty four again in the context of your overall guide as well.
Yeah.
Yeah, we should we should continue to do fairly well and increased margins in health care.
We anticipate that we will continue to get price.
Within healthcare, we also anticipate that some of the pressures surrounding inflation.
Inflation material and labor costs ease, we should also be able to get some productivity increases.
In our health care business.
Just because we had to touch the products. So many times last year.
Okay. Thanks, that's helpful. And then maybe another follow up but bigger picture on and dental you've had that asset now for a couple of years.
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, mostly your commitment to that end market.
One hand, it's a good category for Rollouts, it's fragmented and there's a lot of private companies out there that arent runs in a super efficient way and 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 think strong mid single digit growth for that market even longer term. So maybe you disagree there, but again just love your updated view on.
We head into year, three and stares commitment and participate in that market.
Yes, we remain committed I you know we need to see it through in terms of recovery, we didn't anticipate last year.
Ah sliding into an economic recession that was going to torque. The progress made in terms of procedure recovery that we're seeing dental and 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 they're still I would reiterate there's still a lot of opportunity for operational improvement and deliver improvement in the business and that's something that our status as a long history as good operators of being able to really drive improvements with the business. It would be nice to see the volume resume it makes a you know.
It makes all of those good things that we're doing a.
A much more visible in terms of bottom line performance when when the volume comes back.
Alright, thank you.
Thank you and our next question is a follow up from Michael <unk> from Wolfe Research. Please go ahead.
Thank you for taking the follow up.
I was just looking at you know a lot of a lot of great data disclosed in terms of the reporting you know I could I could explain sequentially the.
The health care consumables line notable step up there clearly levered to.
Seeger and throughput.
Care services line stepped up notably sequentially and I struggle a little bit.
Kind of tying that to.
You know and and market development, so kind of what what happened there Q over Q it was a double digit.
Increase.
Oh, Yeah, 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 some of their products. So that that is a main driver of that plus we shift some capital equipment. Obviously in third quarter, we were able to install that in the fourth quarter. So we generated revenue there. Those those are the two main drivers of that.
<unk> of that business for Q4 improvement.
Thank you.
Youre welcome.
And 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 and look forward to seeing many of you on the road this summer.
Okay.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
Okay.
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