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STERIS plc
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Good morning, everyone and welcome to the STERIS plc First Quarter 2023 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 also note today's event is being recorded.
At this time, I'd like to turn the floor over to Ms. Julie Winter, VP of Investor Relations. Ms. Winter, please go ahead.
Thank you, Jamie 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. We do have a few words of caution before we open for comments from management.
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 forward-looking statements as a result of new information or future events or developments. STERIS' SEC filings are available through the company and on our website. In addition on today's call, non-GAAP financial measures, including adjusted earnings per diluted share, adjusted operating income, constant currency organic revenue growth and free cash flow will be used. Additional information regarding these measures, including definitions is available in today's release including 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 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 first quarter performance.
For the quarter, constant currency organic revenue increased 6%. Growth was driven by organic volume as well as 240 basis points of price. The net impact of acquisitions and divestitures added approximately $151 million to revenue in the quarter, which is broken down by segment in the press release tables. As a reminder, the Renal divestiture will trim revenue by approximately $45 million per quarter through December.
During the quarter, we anniversaried the acquisition of Cantel Medical. Integration continues to go very well. We achieved approximately $20 million of cost synergies in the first quarter and are on track to achieve a total of approximately $50 million in fiscal year 2023.
As anticipated gross margin for the quarter decreased 150 basis points compared with the prior year to 45.1% as pricing and favorable impact from acquisitions and divestitures and were offset by lower productivity and higher material and labor costs.
Material labor costs continue to be a headwind and totaled about $30 million in the quarter. Despite the decline in gross margin, operating margin held flat at 22.9% of revenue compared with the first quarter of last year as we did a nice job of controlling SG&A expenses.
The adjusted effective tax rate in the quarter was 21%. Net income in the quarter increased to $191.1 million and earnings per diluted share were $1.90. At the end of the first quarter, cash totaled approximately $316.3 million. We continue to focus on debt repayment as evidenced by our leverage ratio now being just below 2.3 times.
Our focus on debt reduction continues to provide us great flexibility to make investments in growth capital expenditures and the capacity to pursue potential opportunities to expand our businesses.
Capital expenditures totaled $115.9 million, while depreciation and amortization totaled $138.9 million in the quarter. Our first quarter spend on capital expenditures was higher than anticipated, primarily, driven by the timing of investments within our AST segment. We still expect our full year capital expenditures to be approximately $330 million.
Free cash flow for the first quarter was $117.1 million, as we benefited from increased net income, including a reduction in costs associated with the Cantel Medical acquisition, somewhat offset by higher capital expenditure spending. And finally, last week we announced our 17th annual dividend increase, which raised our dividend by $0.04 to $0.47 per quarter.
With that, I'll turn the call over to Dan for his remarks.
Thanks, Mike, and good morning, everyone. Thank you for taking the time to join us to hear more about our first quarter performance and our outlook for the rest of the year. As you heard from Mike, we had a solid start to our new fiscal year and continue to experience strong demand for our products and services. I will review the highlights of the quarter and then shift my commentary to our revised outlook.
Healthcare constant currency organic revenue grew 4% in the quarter. Strong capital equipment and service growth was offset by an organic decline in consumables, which is largely attributable to the timing of orders against very strong comparisons in the prior year.
Hospital capital spending remains very robust, as evidenced by our health care backlog, which totaled over $500 million at the end of the quarter and our orders for the quarter were 40% large project related.
AST grew constant currency organic revenue 10% in the first quarter, as we continued to benefit from underlying demand from our core customers. Growth was somewhat limited by the timing of large capital shipments from our Mevex business unit which can often be lumpy.
Life Sciences also delivered 10% constant currency organic revenue growth in the quarter, with strong capital equipment shipments and solid mid-single-digit growth in our consumables business. Our Dental segment grew low single digits constant currency year-over-year for the quarter, as revenue was limited by supply chain challenges.
Turning to our revised outlook. From a macro perspective, we have several things impacting our business. As you have heard from many of our peers, currency has moved significantly and the forward rates continue to indicate headwinds on for STERIS in both revenue and profit for the remainder of the fiscal year.
In addition, the supply chain environment has been limiting our ability to ship capital equipment. We believe approximately $35 million in capital equipment shipments were delayed in the first quarter.
While procedure volumes continue to recover, particularly in the US, we are not seeing recovery as quickly as anticipated. The key variable for that recovery appears to be staffing availability at hospitals, which seems to be limiting their ability to catch up with pent-up demand for procedures.
Reflecting these challenges, we are adjusting our revenue outlook for the year. As reported, revenue is now expected to grow 9% and constant currency organic revenue is anticipated to be 10%. As you recall, we grew 13% last year. So double-digit constant currency organic growth on top of that is a significant goal, but one we believe is achievable due to the momentum in our business and strong capital equipment backlog.
While, we are not overly optimistic on supply chain improvements, we do see pockets of improvement there. The real key for us will be relief on parts, in particular, electronic components. In many cases, components are needed to convert our significant work in progress inventory to finish goods so that they can be shipped to customers.
As a result of anticipated easing and supply chain constraints, we expect revenue growth rates to increase at a faster pace in the second half of the year as compared to the first half. Factoring in these elements, our current expectations for earnings are $8.40 to $8.60 for the full fiscal year, a $0.15 decline from the prior outlook, with most of that decline due to foreign currency fluctuations.
For the year, currency is now expected to reduce as reported revenue by $100 million and adjusted EPS by approximately $0.10. The primary drivers of this are the weak euro and British pound.
Overall, our business continues to perform very well in this environment. The challenging environment we're in is no different for other companies. Foreign currency fluctuations are limiting both top and bottom line. Supply chain disruptions are slowing our ability to ship capital equipment and higher interest rates may negatively impact interest expense.
Despite these macro challenges, fiscal year 2023 is still expected to be another record year for STERIS. Our teams and portfolios continue to come together to better meet the needs of our customers, and the breadth of our offering allowing us to take advantage of several significant trends, in the industry, by leveraging our relationships to cross-sell within business segments, and deliver value to our customer. Thank you. That concludes our prepared remarks.
I will hand the call over to Julie, to start the Q&A.
Thanks Mike and Dan, for your comments. Jamie, if you'll give the instructions, we can get started on Q&A.
Ladies and gentlemen, at this time we’ll begin the question-and-answer session [Operator Instructions] Our first question today comes from Mike Matson from Needham. Please go ahead with your question
Hi, guys. This is Joseph, on for Mike. I guess, just first question around guidance. So you guys grew 6.3%, in the quarter looking at 10%. Can you maybe give some detail on, what segments will be driving the acceleration there in the next few quarters? And if you can, maybe some of the pacing of that?
Yes. Obviously, what hurt us this quarter is, capital shipments due to supply chain constraints. Obviously, as you heard Dan talk about, we do believe there are some pockets of strength that are out there. So we believe that capital shipments should continue to get released. Lower surgical volumes, we continue to believe, we're about 95% of procedure value at free COVID. So those should continue to get better. And then, the other big headwind for us outside of just as reported revenue is FX, which both -- is hurting both top and bottom line for us.
As far as the year standpoint, in May we talked about a EPS split of 45% first half, 55% second half. We believe we are still on track for that. And as you heard Dan, talk about revenue will grow and increase sequentially, going forward with more of that growth happening in the back half of the year.
Okay. Great. And then maybe just moving on to the backlogs. I guess, two things to start out. Are you seeing any order cancellations, or any risk that customers are turning to other competitors to meet the demand? I understand, they may also be dealing with the exact same issues as you, but -- I guess, maybe a second part on that. Is there any risk that there's any artificial -- I guess, artificial demand built into these backlogs let's say, from customers double ordering and then canceling the order, that's not fulfilled or going with the company that can fulfill the order first?
Yes – Joseph, we don't see any pattern at all, in terms of, order cancellation. And we continue to see new orders come in at a significantly strong rate. A lot of these are projects, that take longer term, and we've been able to prioritize those projects as they're ready to come online, to make sure we can deliver for our customers. And then we're managing through the backlog, as oftentimes customers projects slip, and others tend to get pulled forward. So we're managing our production, to meet the demand of the customer and shift product where it needs to go, when the customer needs it. It's just challenging right now, because it's a bit hand to mouth at times, with some of the electrical components. But no order cancellations, that we've seen at this point.
Okay.
Yes. And I would just add -- don't remember -- don't forget, we have Cantel in our backlog now. We didn't have Cantel, in the backlog last year. But definitely, as an uptick of about $60 million in the backlog number.
Okay. Okay. Great. That's really helpful. And then, if I can just a really quick one. I think you guys, called out $30 million of increased costs from inflation. Is the $70 million for the year, you guys cited on the last call still accurate?
Yes, we reached $70 million for the year. So, if you remember last year, we were not impacted -- we were impacted heavily -- more heavily in the second half of the year, than the first half of the year. So the $30 million, is the incremental piece. So $45 million last year of headwinds, and $70 million this year, is what we still believe.
Okay. Thank you guys, so much
Our next question comes from Chris Cooley from Stephens. Please go ahead with your question.
Hey good morning everyone and thanks for taking our question here this morning. I just wanted to start if we could on the backlog and your commentary around the supply chain issues. Could you help us think a little bit about how that backlog both on the Healthcare side but also on the Life Sciences front pulls forward versus historical periods? I think you mentioned 40% was project-related when you're in the current quarter in terms of the new order flow.
I'm just trying to think about aging of that backlog a little bit here with these kind of supply chain disruptions that you just cited, you don't expect to get better necessarily in the short run. If you could just provide some color around that that would be appreciated. And then I've got a follow-up.
Yes, Chris, this is Mike. In regards to backlog, as we've talked about for some time, our -- we are getting nice order growth. But at the same point in time, our delays have probably more than doubled in what we typically would see for -- especially around Healthcare. And I'm talking more about the replacement cycles not the project cycle.
So, typically, we would have told you that we get an order in from a replacement standpoint that order would be most likely filled within 90 to 120 days, so most likely in the quarter. That is probably doubled at this point in time. So, that gives you some type of indication as to the lead-times that we're expecting and we're talking to and telling our customers as we're taking the orders.
I don't know Dan do you want to add anything?
Yes, I would just add two things Chris. One, we can -- we are able to build. We are building product every day. We are not losing manufacturing slots. We have a lot of WIP right now though of machines that are 99.7% complete that are awaiting the Golden Screw, if you will, to finish it off in terms of some electrical component.
So, we're -- as we get those components coming in, we'll be able to flush through a lot of backlog in a reasonable amount of time. It's just the timing of those components is still TBD in terms of how it lays out over the next couple of quarters. But generally speaking we're in a good position in terms of manufacturing.
Appreciate the color on that. And then if I could just for my follow-up can we maybe shift gears to the AST franchise? And you cited a little bit higher than anticipated CapEx there in the quarter corporately. I'm just curious if you could give us some color there about the continued build-out of the company's capabilities both domestically and abroad in terms of X-ray and when we could start to see some of that come online commercially? And if in fact that -- or I should say as that does come online, how that measure may not affect the operating margin profile of the business? Thank you.
Sure Chris. We had our first X-ray come online approximately a year ago in Venlo, Netherlands. And very successfully from an engineering perspective and very well-received from a customer perspective the facilities operating significant positive margins within the first year of operation which is not necessarily the norm. So, doing quite well.
The next operation to come online at least domestically here will be in Libertyville, Chicago suburbs and that's likely to be Q4 timeframe for us. So no material impact on the current fiscal year. And then we have other builds going on the West Coast and the East Coast that will follow after the Libertyville operation comes online.
And we have done significant expansions over the last 10 years or so. And the business has gotten large enough at this point that we really don't see any material dilution when we bring a plant online whereas when the business was $200 million that was not necessarily the story but it -- $850 million $900 million we don't see that dilutive effect on EBIT when we bring up a new plant.
And also keep in mind, a lot of these expansions are on existing infrastructure. So, we already have a plant and we're just adding additional warehouse and additional X-ray capabilities or e-beam capabilities to the existing plants. So, they tend not to have the same drain on a cost perspective.
But the goal this year as has been in the past couple of years about $100 million in total expansion CapEx for AST.
Appreciate that color. Thank you.
Our next question comes from Matthew Mishan from KeyBanc. Please go ahead with your question.
Hey guys. Good morning and thanks for taking my questions. Just first on the change in organic growth from 11% to 10%. I couldn't really tell, was that due simply to a slower-than-expected recovery in procedural volumes, or was it also due to some expected push out of the backlog of healthcare capital equipment into the next fiscal year?
Matt it's a little bit of both. We haven't broken out exactly, but it is definitely -- both of those are impacting us on an organic standpoint.
Okay. And you guys had an organic growth decline in consumables in the first quarter. Was that expected, or was it like a change you saw like in June around procedures? And what do you think changed versus your expectations? So you guided sort of mid-to-late May. So you had a pretty good view of what the procedural environment was like midway through the quarter?
Yeah. Matt, this is Dan. Procedures here in the U.S. were slightly below where they were in the first quarter of last year, according to all of our data that we have at STERIS, but slightly. And so I don't think that had a material effect on the consumable consumption or shipments.
The issue is really we had a pretty strong quarter last year, I think as there was some restocking going on in hospitals and some distributor orders. So I think it was just a matter of tough comps and timing. And I'm confident that will flush out in Q2.
Okay. And then just lastly on AST and the sort of the change in organic growth from last several quarters still double-digit growth is still positive. Can you go back and explain, what you're describing around the timing of some shipments and growth being limited by that.
What that actually is? And do you expect that to be on a normal trajectory -- maybe know what a normal trajectory is -- your previous trajectory as you get through the next couple of quarters?
Yeah. So that related to some capital equipment shipments from our Mevex business unit. And those are typically E-beam Accelerators and Conveyance Equipment Control Systems. And the issue is we don't recognize revenue until those things get fully installed and get through an FAT process and then we recognize revenue.
To the extent that we have some delays either on our end from a delivery perspective or more often is the case as the customer is delayed on whatever construction or infrastructure they have to have in place for us to finish the project.
So as a result, our system can be a few million dollars or more even $5 million, $6 million potentially. And if that slips from recognition perspective from one quarter to the next is pretty material in terms of impacting growth rate.
So, normally we had planned to ship close to $9 or so million. And we shipped considerably less than that. I think had we moved the equipment the way we had originally planned, our organic growth rate, constant currency organic growth rate for AST would have been the mid-teens comfortably where it's been in the past.
But the equipment business is a little lumpy right now. And as you know building anything either, whether it's our customers or us construction things are not necessarily tied to a definitive schedule these days.
Okay. And just a quick follow-up is how much is CapEx? And how much is capital equipment as a part of the AST business in a typical year?
It's small about $30-ish million, ballpark out of the eight or something, yes.
All right. Thank you.
Yeah.
Thank you.
Yeah.
Our next question comes from Michael Polark from Wolfe Research. Please go ahead with your question.
Hi. Good morning. Thank you for taking my questions. A follow-up on the adjustment to the organic growth outlook, I'm just curious, why one point was the right number? Why not two why not three? Why not maintain the prior one?
Like, philosophically, how you got there? How you feel about the adjustment? Is there risk? Where are the risks from here, or do you feel like you have a very proper set of inputs now? Any color on that helpful. Thank you.
Yeah. We talked a lot about it internally. And if not, for the fact that we are sitting on this enormous backlog number, it comes down to what's our confidence in our ability to execute and ship based on materials.
And I think that things have changed pretty significantly even in the last few weeks, around our line of sight of when we'll start getting consistent component deliveries that we need to finish out this equipment. So, we have a little more confidence now that we'll be able to flush a lot of this out. in the back half of the year and we're already well prepared to do that. So that's what give us -- gave us the confidence to stay at 10%. And then I do believe that despite where procedure rates are now, I don't see us getting back to pre-COVID levels during our fiscal year. But we do anticipate them to tick up a bit barring there's no unforeseen new variants that shuts down hospitals again or something like that.
On the backlog, my perception has been generally the mix of that -- of healthcare equipment revenue ex-Cantel is 50:50 kind of OR SPD ballpark. As you look at what's sitting in the backlog that needs to be finished and shipped does it skew SPD or, or is it fairly balanced?
It's typically heavier on the SPD side because we tend to do more term -- quicker term business on the OR side. So -- we have a lot of backlog in sterilizers and washers right now.
And Cantel as well.
Yes Cantel as well.
That $60 million that we're talking about is 100% at SPD basis.
Yes. Okay. That's what I suspected, I appreciate that. On pricing, I believe the prior guidance for the full fiscal year included 200 bps year-on-year, Mike I think you called out 240 basis points in the quarter. So just anything to call out in the quarter, why it was higher than the guide or has the expectation for pricing in the guidance changed?
I would say that our pricing -- 200 basis points of pricing for the year is still within our guidance. Every quarter could be a little bit different as typical, depending on the mix of the products and stuff like that. But the nice thing that we're getting, we actually are getting price segments for the first time in a long time. And obviously, as you guys know, we typically get less than 100 basis points of price. So, we've done a nice job of increasing the pricing power that we had to offset, as everybody knows the higher labor and material costs. And even then, we're not even offsetting it one for one, yes.
Again, do one last one on just how you're thinking about capital deployment. The balance sheet flexibility is starting to ramp back up. Historically you've liked to do deals. I'm curious kind of is that taking up a lot of time right now or is M&A pipeline kind of relatively slow activity?
No, we continue to look at and do even some small sort of bolt-on acquisitions and we'll continue to do that over the next year or so. In terms of anything significant in size, right now we've got plenty of work finishing the integration of Cantel and also working through getting products delivered to our customers. So even though we have the financial firepower to do that, we want to get the business running and like it should be and continues to do so, so that we can do potential other business development in the future. But for right now, we'll probably take a couple of quarters off.
Thanks for the question.
Our next question comes from Jason Bednar from Piper Sandler. Please go ahead with your question.
Hey, good morning. Thanks for taking the questions here. I wanted to go back to the procedure volume softness that you referenced. STERIS clearly isn't alone as a staff issue seems to be hitting a lot of players here in Medtech. But I guess I wanted to take your temperature on your visibility, regarding how much of this truly is staffing which may recover more slowly versus something that might be a bit more transient like higher than normal COVID infection rates that might be leading to things like procedure cancellations and possibly perpetuating the staffing challenges. So are there any maybe regional variances too that stood out just on -- as the procedure volumes were coming softer than you expected?
Yes. Look it's complicated, is what I would say. And yes, there are unexplainable regional variances too. We saw a significant more of a decline in the Southeast than we did in the Midwest or Northeast or West Coast. Yes, I can't explain it to be honest with you, in particular that. What I would say is, the single biggest issue is staffing.
And your question did COVID uptick in June impact that, in terms of cancellations or staff shortages probably -- that probably explains a little bit of a percent or so decline versus what we saw in Q1 last year. But I'm guessing at this point. I truly believe it's staffing. Every single hospital CEO that we speak to their single biggest challenge right now is staffing and not just nursing. It's in general facility staffing, it's the janitorial, it's the food service. It's -- there's a reason why you're looking at inpatient rates dropping significantly in outpatient rates going up significantly because the hospitals just don't have the staff to care for people that are in-patients.
Okay. Yes. Very, very clear. That's helpful. Thanks. And then on Dental based on reports from others out there in your comments today it sounds like challenges are just really just continuing across the Dental market. But love to get your updated view on how you see your Dental business do. And as you get it back on track, how much can you do to help STERIS maybe buck the trend of the broader market.
And then is the sequential improvement in operating margin for that segment that we saw here today or yesterday. Is that sustainable? Then any time line you're willing to put on when that segment gets to kind of the above corporate average target that you've laid out in the past?
Yes. What I would say is Dental if not for the supply chain issues we had this quarter, would have had a really nice quarter in terms of growth. So we didn't lose that business that will just flow through in the coming quarters in terms of demand. And so I think that will sort itself out in terms of the overall financial performance on the bottom line, that is a process of continuous improvement, and it's something that we are going to work on every day, every month, every quarter, every year, but it's not there's no magic wand to do this correctly. So, we'll continue to do what we need to do to strip out waste and cost. Obviously, look at price where it makes sense, and continue to innovate with new products, so that we can bring high value to our customers.
Got it. And then Mike just one more if I could a bit of a housekeeping item. Sorry if I missed this, but can you help with the currency rates for the euro pound and Canadian dollar that you're using and forecasting out the updated $100 million in FX headwinds for this fiscal year? Thank you.
Yes, certainly. So we use the forward rates and we use them as of the end of June. The euro is at a $1 -- or $1.060, the pound is at $1.222. Those are both significantly lower than what we planned originally.
That was perfect. Yes. Understood. Thank you.
Yes. You’re welcome.
[Operator Instructions] Our next question comes from Dave Turkaly from JMP Securities. Please go ahead with your question.
Great. Thanks. Maybe just a quick follow-up. So if we're looking at your performance in Healthcare and then your guidance, I think, it was 4% this quarter. I mean, can you help us understand how you're able to grow, I guess, a lot faster if we're looking at flat to down procedures and maybe some improvement, but not totally back to where we were pre-COVID. Is a mid-single-digit range is that -- can you deliver that for that -- the largest business for you?
Yes. What I would say is, over the last year or so, we've done a nice job of taking share in our recurring revenue business, our services business, our chemistries business and BI or CIs. And we expect that to continue and help offset some of the natural appreciation that we would have hoped to have seen a procedure rate.
Now the reason that takes us from mid-single digits or mid to high single digits into much higher than that as the capital backlog we're sitting on right now. And we continue to bring in backlog and grow or maintain that backlog based on our order rates. So that's the reason why we think we can get a much higher growth on top out of Healthcare is flushing through the backlog that we had at hand.
Got it. And then maybe just a quick follow-up on AST. Obviously, it's been -- it's delivered for you or you guys have executed well in terms of the growth profile. But -- how do you think of that looking out, maybe even versus your 10% for the company? I mean, is that a mid-teens grower on a consistent basis looking forward?
Yes, it's double digits, but it's not mid-teens. I think that -- I mean, it's done incredibly well over the last couple of years in terms of mid-teen looking growth rates. But having been in that business for 25 years, that has not been the norm for the life of the business. So, I would expect it to normalize back towards double digits or slightly below at some point in the future. I think for the short term, we're going to maintain above double-digit growth.
Thank you.
And our next question is a follow-up from Chris Cooley from Stephens. Please go ahead with your follow-up
Thanks. Good afternoon. Appreciate you taking the follow-up question. I guess I'll get more than two in like everybody else. The -- quick question on cash flow. You guys maintained cash flow guidance for the full year, but it sounds like, there's obviously upward pressure on both, net interest expense, probably a little bit higher working capital need. I just want to make sure I fully understand the puts and takes that you expect to see throughout the remainder of the year that gives you confidence in your ability to hit that cash flow target that you previously established. Thanks, so much.
Yes Chris, two things there. Our collections efforts have been strong, which is helping improve working capital. And then as we've talked about for the last 25 minutes, the backlog, when we ship that backlog, we should get improvement in inventory which means it flows through to the receivables side. So that's where we believe, we have the ability to maintain our free cash flow projection at $675 million.
Thanks.
And ladies and gentlemen, at this point, I'm showing no additional questions. I'd like to turn the floor back over for any closing remarks.
Great. Thanks, Jamie and thanks everybody for taking the time to join us this morning.
Ladies and gentlemen, that does conclude today's conference call and presentation. We thank you for joining. You may now disconnect your lines.