Good day, and welcome to the STERIS plc Q4 2022 results conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Julie Winter with investor relations. Please go ahead.
Thank you, Chad, and good morning, everyone. As usual, speaking on today's call will be Mike Tokich, our Senior Vice President and CFO, and Dan Carestio, our President and CEO. I do have a few words of caution before we open for comments. This webcast contains time-sensitive information that is accurate only as of today. Any redistribution, retransmission, or rebroadcast of this call without the express written consent of STERIS is strictly prohibited. Some of the statements made during this review are or may be considered forward-looking statements. Many important factors could cause actual results to differ materially from those in the forward-looking statements, including, without limitation, those risk factors described in STERIS' securities filings. The company does not undertake to update or revise any of these forward-looking statements as a result of new information or future events or developments.
STERIS's SEC filings are available through the company and on our website. In addition, on today's call, non-GAAP financial measures, including adjusted earnings per diluted share, adjusted operating income, constant currency organic revenue growth, and free cash flow will be used. Additional information regarding these measures, including definitions, is available in today's release, also along with reconciliations between GAAP and non-GAAP financial measures. Non-GAAP financial measures are presented during this call with the intent of providing greater transparency to supplemental financial information used by management and the board of directors in their financial analysis and operational decision-making. With those cautions, I'll hand the call over to Mike.
Thank you, Julie, and good morning, everyone. It is once again my pleasure to be with you this morning to review the highlights of our Q4 performance. For the quarter, constant currency organic revenue increased 11%. Growth was driven by organic volume as well as 120 basis points of price. Acquisitions added approximately $253 million to revenue in the quarter, which is broken down by segment in the press release tables. Gross margin for the quarter increased 120 basis points compared with the prior year to 45.5% as favorable productivity, pricing, and acquisitions were somewhat offset by higher material and labor costs. We continue to face increased material and labor costs, which totaled about $20 million in the quarter as anticipated.
EBIT margin for the quarter was 23.6% of revenue, an increase of 130 basis points versus the prior year. This is impressive performance as operating expenses, including R&D, increased, plus the continued headwind from supply chain and inflation. The adjusted tax rate in the quarter was 22.8%. Net income in the quarter was $205.4 million, and earnings per diluted share were $2.04. At the end of the fiscal year, cash totaled $348 million. We continue to focus on debt repayment as evidenced by our leverage ratio being now under 2.4 times at the end of the fiscal year. Our focus on debt reduction provides us flexibility to continue making investments in growth capital expenditures and allows us many opportunities to continue to expand our businesses.
Year to date, capital expenditures totaled $287.6 million, while depreciation and amortization totaled $553.1 million. Free cash flow for the year was $399 million. As anticipated, this is a decline from the prior year due to costs associated with the acquisition and integration of Cantel, along with higher capital spending year-over-year. As we look forward to fiscal 2023, we anticipate free cash flow generation of approximately $675 million as the majority of costs associated with the acquisition and integration of Cantel have occurred. We also expect interest expense to be higher year-over-year as rates continue to rise. Total non-operating expenses net is anticipated to be about $95 million.
In addition, we expect to continue reinvesting in our businesses with capital expenditures totaling approximately $330 million. With that, I will turn the call over to Dan for his remarks.
Thanks, Mike, and good morning, everyone. Thank you for making the time to join us to hear more about our fiscal 2022 performance and our outlook for fiscal year 2023. As I look back on the year of fiscal 2022, it was a remarkable year for STERIS. Not only did we navigate year two of a global pandemic, but we also completed the acquisition of Cantel while integrating Key Surgical and successfully transitioned leadership, all while growing faster than anticipated. I wanna start by thanking the people of STERIS for all they have done and continue to do to support our customers and each other. Without all of you, we would not be where we are today. We started fiscal 2022 with an expectation of 8%-9% constant currency organic revenue growth for the year.
After increasing our outlook twice this year, we ended the year with 13% constant currency organic revenue growth, well above our increased outlook. This growth was driven by continued outperformance of our AST segment, double-digit growth in healthcare, and solid mid-single-digit growth in the life sciences. While dental is not yet included in the constant currency organic revenue growth, the segment grew 4% year-over-year since the time of acquisition in June. From a profit perspective, we ended the year with operating margins up 100 basis points, despite absorbing about $45 million in unplanned supply chain and inflation costs related to labor. Helping to offset those costs, we were successful in overachieving our fiscal 2022 cost synergies targets for the Cantel acquisition, which added approximately $40 million to our fiscal 2022 results.
Adjusted earnings per diluted share of $7.92 increased 28% compared with fiscal 2021 and reflect a new record for STERIS. Turning to fiscal 2023, at a high level, we expect another very strong growth year for our business. Our outlook for total revenue calls for approximately 12% growth, which includes two additional months of the Cantel acquisition, offset by the impact of the Renal Care divestiture, as well as approximately $30 million in unfavorable foreign currency. Excluding all that, we anticipate constant currency organic revenue growth of approximately 11%. Importantly, this outlook assumes that the procedure volumes will normalize in the U.S. and that we do not experience any significant wave of disruption from COVID. Our constant currency organic revenue outlook reflects volume growth and includes 200 basis points of favorable pricing.
Pricing is essential to help offset the increased cost year over year. For fiscal 2023, we expect an incremental $70 million in extraordinary supply chain and labor inflation costs above the $45 million we incurred in fiscal 2022. This is in addition to our normal low single-digit annual inflation amounts, all is included in our outlook, which we'll work to overcome every year. In addition to the anticipated headwinds from supply chain and inflation, our fiscal year 2023 operating expenses will be higher as we get back to spending on travel, sales and marketing and other expenses. R&D spending is also anticipated to be higher as we continue to develop and bring new products to our customers. Offsetting those headwinds, to some extent, will be cost synergies from the integration of Cantel, which is expected to be incremental by approximately $50 million from the fiscal 2022 levels.
By the end of fiscal 2023, we will be approaching $100 million in total cost synergies achieved. Taking into consideration all of the puts and takes, we expect to show modest operating margin growth in fiscal 2023. Our full year earnings per diluted share outlook is anticipated to be in the range of $8.55-$8.75, or 8%-10% growth over fiscal 2022. Given all the moving pieces, we are pleased with this bottom line growth outlook. As usual, the range does provide us some conservatism on the low end. Given all the uncertainty that exists, we believe it is warranted. All in all, fiscal 2023 is expected to be another record year for STERIS. Our teams and our portfolios continue to come together to better meet the needs of our customers.
The breadth of our offering allows us to take advantage of several significant trends in the industry by leveraging our relationships to cross-sell within the business segments. I recently shared with our sales team in our first in-person global meeting in three years, that we honestly believe that STERIS is positioned better today to meet the needs of our customers than ever before in history. That concludes our prepared remarks for the call. Julie, please give the instructions so we can begin the Q&A.
Thank you, Mike and Dan, for your comments. Chad, if you would give the instructions, we'd be happy to get started.
Certainly. To ask a question, you may press star then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. The first question will be from Chris Cooley from Stephens. Please go ahead.
Good morning. Thanks for taking the questions, and congratulations on a stellar year there in fiscal 2022. Just two for me, if I may here this morning. First, just in thinking about kind of how you're looking at the year going forward, you know, 11% constant currency growth obviously is higher than what we've historically seen the company start out with. Admittedly, there's some different aspects to the business. Just would appreciate if you could maybe, you know, call out, you know, where you're seeing strength, where you need to see some improvement, just from operationally from a divisional perspective, so we can kind of think about that in terms of the drivers, both of growth and then as a result, margin as we go through the year. Then I've got a quick follow-up. Thanks.
Yeah. Thanks, Chris. This is Dan. Thank you for the question. You know, in short, you know, we're seeing a fairly robust recovery in procedure volumes, you know, on a quarter-to-quarter basis, as we move back into more normalized volume in terms of pre-COVID levels. We're not there yet. We still have quite a ways to go. You know, I think that the real governor on the recovery of those rates is gonna be staffing and the challenges that's generally present in the healthcare industry today, in particular in the hospital segment. You know, having said that, as those volumes return, that significantly benefits both our global healthcare business as well as the AST business.
We've seen, you know, in the last couple quarters, a recovery of more and more devices coming through AST in particular that are more highly elective, high value type devices, so ortho, spine, things like that, of that nature. As those procedures begin to recover and then start working off what's been a couple year backlog of pent-up demand, we're seeing higher growth opportunities than we've seen maybe in the past. In addition to that, you know, we're coming into the year with, you know, all-time record backlog from a capital equipment perspective. You know, as we hope to flush that through over the course of the year, that will obviously be a bit of a tailwind for us in terms of our revenue growth.
Appreciate the color. Just as my follow-up, I appreciate all the detail here, but a number of puts and takes when you look down through the middle of the P&L, as we go into fiscal 2023. Just kind of curious, you know, you're talking about a return to kind of normalcy when I think about SG&A more broadly, higher R&D as well. I guess directionally, how much of this is a return to normal? How much of this is incremental investment that you're, you know, making for kind of the sustainability of the growth of the business? Or, you know, was the business maybe underinvested in over the course of the last 18-24 months?
Just trying to get a better feel for, you know, what kind of structurally we should be thinking about longer term just from an expense rate. Thank you.
Yeah, Chris, this is Mike. I would say that the majority of what we're going to experience, at least in the SG&A side, is more a return to normal. I would not say that we were underinvested by any means. As Dan said in his prepared remarks, you know, we've had our first sales meeting in three years, so you can imagine the expense of that compared to the last two years that we didn't have that. Those are the types of increases we're talking about. Where you're going to see a little bit of a stepwise change, though, is in R&D. R&D, we anticipate growing by double digits in fiscal 2023. We continue to make investments in R&D to bring new products across all of our businesses.
That is, if you look at the two, a stepwise change that we are continuing to invest for the long term. Not that we were underinvested by any means. We just think there's a lot more opportunity that we can bring forth, especially with the acquisition of Cantel.
Appreciate that, Mike. Thanks so much. Again, congratulations on a great year.
Thanks, Chris.
Thanks, Chris.
The next question comes from Mike Matson with Needham & Company. Please go ahead.
Yeah. Thanks for taking my question. I guess I'll start with just the Q1 in 2023. You've got a bit of a tougher organic comp, I think. I mean, I didn't hear any kind of directional commentary around where you expect the revenue. I mean, is it safe to assume you're comfortable with where consensus was sort of modeling things? I mean, I'd assume it's lower, you're expecting lower organic growth in the Q1 than the remainder of the fiscal year.
Yeah. Mike, this is Mike Tokich. We have not made any comments, but to give you a little bit more color to help you with your modeling, we would suggest that from a first half versus second half, we're about 45% first half, 55% second half, which is typical of how we operate. To your point, I think I would say you are correct. We do have a little bit of a tougher comparison in Q1, but we're not going to give quarterly guidance at this point in time, and nor have we in several years.
Just to clarify, that's for this earnings?
Yes, you're correct.
Okay. Got it. That's helpful. All right. You mentioned you know that there are some trends in the industry that are helping STERIS. I was wondering if you could just talk a little bit more about that. I'd assume one of them is the trend toward ASCs, where the ASCs kind of have to get outfitted with cleaning and sterilization equipment and whatnot, but maybe just talk about some of those industry-wide trends.
Yeah. That is one, clearly. Sorry, this is Dan. There's an awful lot of growth going on in investment, both in acute care and in ASCs, you know, across the U.S. in particular, and we're starting to see the recovery in Europe. We've been really well positioned with our portfolio of products, in particular with SPD and also, you know, from an OR perspective over the past few years, and we're nicely positioned to fill that need and that growth that we're seeing as it comes. You know, the other sort of tailwind that we're getting is, as I mentioned before, just general procedural recovery, which drives our consumables, it drives our services, it drives our AST business. That's generally beneficial for STERIS whenever we see procedure rates on the rebound.
You know, sort of last but not least, there's no shortage of investment going on in pharma in terms of aseptic manufacturing as it relates to biopharma and to some extent vaccine as well. You know, we have an awful lot of backlog in life science that's gonna flush through this year as it relates to some of the expansions that and investments we've seen going on in the industry. As those investments come online, that's a tailwind for us with our consumables business as they start to consume our chemistries and our packaging solutions.
also with AST as well.
Yeah, obviously within AST, biopharma and procedural recovery is a tailwind for our AST business.
Okay. Got it. Thanks. Just as far as the free cash flow guidance goes, I mean, I'm having a little trouble getting to the $1 billion of cash flow from operating activities in my model. I mean, I'm coming in higher than that, but the only way I can kinda get there is assuming your working capital is up a fair bit. I mean, is that a reasonable assumption? Is that, you know, maybe you're stocking up on inventory and things, like pre-buying stuff because of the supply chain issues? We've heard that from other companies.
Yeah, Mike, that's exactly right. We have been doing that for probably the last 18 months to 2 years, where we've continued to carry higher levels of inventory. When we ship the backlog, obviously the inventory and if supply chain does get a little bit easier, we will actually be able to bring that inventory level down as we go throughout the year.
Yeah. Our philosophy on inventory has gone from just in time to just in case. There's an awful lot of contingency and supply chain continuity built into our inventory levels right now.
Okay. Got it. Thank you.
You're welcome.
The next question is from Matt Mishan from KeyBanc. Please go ahead.
Hey, good morning, and thank you for taking the questions. I just wanna start first with the healthcare capital equipment. At least versus our model, it looks like it came in a little light in the Q4 . Did some of the backlog get shipped from the Q4 into FY 2023?
Yeah, Matt, as we've been talking about the last couple quarters, we have seen roughly $30 million-ish that did not ship that would have been scheduled to ship on a normal course, if you will.
Okay. If you look at it and you say that's like add to that a percent. As you compare the 11% organic growth for FY 2023 to what is a more sustainable level of organic growth, you kinda back out that capital equipment. I guess price is probably not, you know, 200 basis points moving forward. Just what do you, how do you look at what is a sustainable level of organic growth compared to the 11% for 2023?
I would say, Matt, we are still in the mid- to high-single-digit revenue growth on our long-term aspirations. Obviously, we've done better than that over the last several years. You know, in general, we would still stay with that forecast or that thinking from a long-term perspective.
Okay. Then just, Dan, just your longer term thoughts on hospital capital spending as it progresses through the year. I think we've seen a couple of different opinions from some companies on kind of where that's potentially moving.
Yeah, you know, we've seen those opinions as well. I think some of the differences is, you know, the capital equipment that STERIS is selling is typically $20,000-$100,000 pieces of equipment. So these aren't $1 million, $2 million machines that. The other point I would make is, you know, everything we sell basically is procedural rate driven, and it's almost like a utility at times for the hospitals. They have to have it in order for them to accommodate an increase in surgical procedures, you know, whether that's lights and tables or whether that's stuff in the SPD.
Generally speaking, given the cost of our equipment and sort of the utility of it in nature, we see continued strong investment. How long it'll last, you know, I don't know. We don't see it changing any time in the near future.
Excellent. Thank you very much.
The next question is from Michael Polark with Wolfe Research. Please go ahead.
Hi, good morning. Thank you for taking the questions. One clarification on the response to Mike Matson's question. The 45-55, Mike Tokich, was that a comment on revenue progression, 1H to H or EPS?
That, Mike, that was on EPS.
Okay.
Welcome back, Mike.
Thank you.
Welcome back to covering us.
That was three Mikes in my first question, too. Three Mikes too many. Maybe on fiscal 2023, to level set, comments or frameworks like this have been made in the past. I don't think. I'm not struggling too much, but would you be willing to level set in your, you know, $5.1 billion, give or take, of imputed revenue for fiscal 2023, how that splits out across the segments, just so we can work the model a little bit more precisely?
We have not done that, Mike, and I think at this point in time, we will not. I will tell you that for the most part, if you look at growth, healthcare is going to be exceeding their normalized growth. I would say life sciences will be somewhere in maybe a little bit better than the normalized growth. AST will be at its normalized growth.
Obviously, dental, we still don't have a true comparison at that point in time.
Okay. Dental, what's the early assessment of dental? I would say this is the one piece of the acquisition that hasn't, you know, impressed yet. Kind of how do you feel about that business? What are the, you know, work streams and initiatives for fiscal 2023, as you continue to integrate it and learn that market?
Yep. This is Dan, Mike. Yeah, we're happy with the business. You know, I would say it is more affected recently, in particular with the surge of Omicron that we saw in the January, early to February timeframe. Unlike healthcare, where it had very little effect, just the broad level of infections across the U.S. in particular ended up postponing or delaying a lot of procedures in the dental space. If you wanna fact check that, call your dentist today and see if you can get in before July, because there's a lot of pent-up demand in terms of lost time in the first couple months anyways of this calendar year. We like the business.
We think there's a ton of operating opportunities in terms of driving efficiencies through lean and continuous improvement that's gonna take us some time to wring out and make the business a little more efficient in terms of how they serve their customers. Other than that, it's on a steady track of recovery in terms of demand barring what we saw the first couple months of the calendar year.
Mike, just to add to that a little bit, I mean, we grew 4%, since the acquisition, which is a little bit below, to Dan's point, because of some of the COVID impacts, which is a little bit below the mid-single digits anticipation that we would have for that segment, to give you some further clarity.
4%, that's like a pro forma-
Correct
growth rate for the business? Okay.
Yeah.
If I can do one more, the comments on R&D are interesting. Obviously, STERIS is not overly reliant on any single product, and so I don't wish to overstate the importance of any single product category with this question. I have noticed that you have recently launched, relatively recently, I think this year or late last, a single use ureteroscope, and you know, it's always a topic that seems to come up from time to time, and I'd just be curious about your efforts there and if you know, this launch is an appetizer to some more products in that single use scope category over time. Thank you so much for taking the questions.
Sure, Mike. Yeah, we're in a limited market release right now in terms of the new scope, and we've received a lot of positive feedback from key opinion leaders. It's early days at this point, and you know, we'll see how that goes and how it progresses over time. What I would say is that STERIS is uniquely positioned with our IMS business and vast understanding and engineering that we have around scope design from our repair perspective. That collaboration you know with the commercial teams has put us in a nice position in the urology space. You know, as that product begins to go into more realistic launch, you know, we'll be able to provide some update and information on it.
At this point, it's just too early days for us to discuss it.
Thank you. The next question will come from Dave Windley from Jefferies. Please go ahead.
Hi. Thanks for taking my questions. Most of them follow-ups. You've commented on the recovery in volumes broadly, I'm thinking, predominantly healthcare and AST, but I'm wondering if you could comment on whether you see the primary drivers of those volumes being kind of recovery of pent-up demand, as you've mentioned, how much might be market share gains and any other contributors to that?
Well, I mean, I think in terms of procedure volume, that's pretty straightforward. As you know, we're back now, in the U.S. market anyway, somewhere around 95% pre-COVID, depending on where you are, region to region. Some hospitals may be operating at 100%, others are operating at 90% or so. Over time, I think as provided the staffing can step back up in terms of meeting the full demand, we'll see that improve beyond, you know, what we saw pre-COVID, because there is a lot of pent-up demand. But there's also a lag now in terms of intake with the hospitals, you know, getting people back into the system, where they're diagnosing disease and moving them towards surgery where necessary. That is slower to recover as well.
It's gonna take some time. In terms of overall rates and demand on the different businesses, in terms of overall growth rate, I do believe we're taking a bit of share across the majority of the businesses here at STERIS. We've discussed that in the past, and we've made very significant investments in our portfolio, as it relates to, you know, healthcare and life sciences over the years, and also, you know, in significant capacity expansion investments in AST. And consequently, I think we're doing a little bit better than market in those spaces.
Great. Thanks. follow up, different topic around capital structure. You mentioned leverage, I think, was 2.4 times, mentioned rising interest rates and a big recovery in the coming year in your free cash flow expectations. Maybe just talk about general capital deployment, priorities and I'm kind of getting at how much floating interest rate debt do you have, and is the rising interest rate environment encouraging you to pay off more of that more quickly?
I would say that in general, as we are, you know, anticipating about $675 million in free cash flow, that our capital priorities have remained basically the same for the last decade or more. We're off the top, we believe in increasing our dividends. We've done that 16 years in a row. Next would be to continue to invest in ourselves, and we're continuing to do that. Anticipating about $335 million of CapEx, which is almost $50 million higher compared to the prior year. A lot of that CapEx is gonna be continued, directed into our AST segment as we continue to expand our facilities and our opportunities in that segment. Third would be looking towards M&A.
We've done over 50 transactions in the last 10 years or so. Most of those are tuck-ins in nature. I would imagine that most of those in the future, as we continue down the M&A path, will be tuck-ins. Then finally, just from a repurchase, share repurchase standpoint, just to offset dilution, and we have that built into our plan for this year. We did do about $25 million of share repurchases in Q4, but we had a hiatus on share repurchases for the last 18 months or 2 years. From a prioritization standpoint, that is how we operate and how we have continued to operate over the last several years.
From a debt-
Got it. Thank you.
Dave, just I think you asked about debt. About a quarter of our debt is floating rate debt.
Okay, thanks.
Again, if you have a question, please press star then one. The next question is a follow-up from Chris Cooley from Stephens. Please go ahead.
Oh, thanks for taking the follow-up here. Just two quick follow-ups for me, if I may. Could you speak to the margin profile in the dental business? I'm just trying to get a better sense of, you know, we saw sequential progression downward throughout fiscal 2022. How much of that decline in the Q4 was volume related? It does sound like that impacted you from a response to a prior question. But just when we should maybe start to expect stabilization there or maybe a lift better. And then it's just a quick follow-up. I'd be curious if you could discuss or provide any additional color when you think about the AST build-out that continues to take place, emphasis on different sterilization modalities, in particular, X-ray here in the United States and abroad. Thank you so much.
Dan, I'll take the dental one, and I'll give you the AST one, if that's okay.
Yep, sounds good.
On the margin profile of dental, Chris, you are correct. We have seen a degradation in our EBIT margins in that business. In the Q1 that we had dental, they were still not being impacted like the rest of the business from a materials and labor inflationary standpoint. That has changed dramatically in the back half of our fiscal year, so that is one large driver, impact, negative impact to dental. Then as we talked about earlier, volumes with patients has definitely had a negative impact on that business.
I would say that in general, we would look to have dental above our corporate average, as we continue to streamline that and get more ingrained in the operations of that business longer term. Definitely volume and then the inflation is definitely having a larger impact on that segment on its own.
Understood.
Yeah. Chris, on the AST question, you know, we're in the process of a pretty significant build-out across our network and actually across multiple technologies. We have, you know, a few E-beam plants going in. We've got a couple of EO expansions, you know, in addition to the numerous X-ray facilities that are currently in one phase of build or another, which, you know, construction during the COVID environment and labor shortages has been nothing short of challenging for the last couple of years. It's definitely looking up recently. In particular in the U.S., there are three facilities that'll come online over the next couple of years.
The earliest will be late, very late this fiscal year, most likely, in Illinois, and then followed by either California or Chester, New York.
Thank you.
Ladies and gentlemen, this concludes our Q&A session. I would like to turn the conference back over to Julie Winter for any closing remarks.
Thanks, everybody, for taking the time to join us this morning. We look forward to catching up with many of you live in the coming days.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.