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Edited Transcript of STE.N earnings conference call or presentation 14-May-19 2:00pm GMT

Q4 2019 Steris plc Earnings Call

May 27, 2019 (Thomson StreetEvents) -- Edited Transcript of Steris plc earnings conference call or presentation Tuesday, May 14, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Julie Winter

STERIS plc - Senior Director of IR

* Michael J. Tokich

STERIS plc - Senior VP, CFO & Director

* Walter M. Rosebrough

STERIS plc - CEO & President

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Conference Call Participants

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* Christopher Cook Cooley

Stephens Inc., Research Division - MD

* David Louis Turkaly

JMP Securities LLC, Research Division - MD and Senior Research Analyst

* Jason Andrew Rodgers

Great Lakes Review - VP

* Lalishwar Mitra Ramgopal

Sidoti & Company, LLC - Healthcare Sell Side Analyst

* Lawrence Soren Keusch

Raymond James & Associates, Inc., Research Division - MD

* Matthew Ian Mishan

KeyBanc Capital Markets Inc., Research Division - VP and Senior Equity Research Analyst

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Presentation

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Operator [1]

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Good day and welcome to the STERIS plc Fourth Quarter 2019 Conference Call and Webcast. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Ms. Julie Winter, Senior Director and Investor Relations. Ms. Winter, the floor is yours, ma'am.

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Julie Winter, STERIS plc - Senior Director of IR [2]

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Thank you, Mike, and good morning, everybody. As usual, on today's call we have Walt Rosebrough, our President and CEO; and Mike Tokich, our Senior Vice President and CFO. And I do have a few words of caution before we open for comments.

This webcast contains time-sensitive information that is accurate only as of today. Any redistribution, retransmission or rebroadcast of 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 forward-looking statements as a result of new information or future events or development. 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, segment 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 over to Mike.

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Michael J. Tokich, STERIS plc - Senior VP, CFO & Director [3]

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Thank you, Julie, and good morning, everyone. It is once again my pleasure to be with you this morning to review the highlights of our fourth quarter performance.

For the quarter, constant currency organic revenue growth was 9% driven by volume and 70 basis points of price. Gross margin for the quarter increased 190 basis points to 43.8% and was impacted favorably by productivity, mix, price and currency, somewhat offset by higher labor costs and the impact of tariffs. EBIT margin for the quarter was 22.1% of revenue, an increase of 170 basis points from the fourth quarter last year. The adjusted effective tax rate in the quarter was 19.2%, somewhat lower than we had anticipated due to favorable discrete items along with stock -- the benefit of stock compensation expenses. Net income in the quarter grew 24% to $131.1 million, and earnings increased to $1.53 per diluted share, benefiting from revenue growth, margin expansion and a lower effective tax rate.

In terms of the balance sheet, we ended March with $220.6 million of cash and $1.2 billion in total debt. During the fourth quarter, capital expenditures totaled $76.5 million, bringing our total spend for the full fiscal year to $189.7 million. Free cash flow for fiscal 2019 increased to $355.4 million mainly due to improvements in cash from operations.

With that, I will turn the call over to Walt for his remarks

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Walter M. Rosebrough, STERIS plc - CEO & President [4]

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Thank you, Michael, and good morning, everyone. We appreciate the time y'all take to discuss our recent performance and our outlook for the new fiscal year. Our message today is simple. We had a strong FY '19 on both the top and bottom line, and we have a solid momentum heading into fiscal 2020.

Underlying demand from our customers and success with new products contributed to 8% constant currency organic revenue growth for the full year, meaningfully above our expectations. Part of that demand was related to a onetime benefit of customers building inventory. As you probably know, many companies had supply chain concerns regarding Brexit. This resulted in some of our customers desiring safety stock ahead of the original March 29 Brexit date.

Our AST and Healthcare Specialty Service segments led the way this year in growth rates for fiscal 2019, each increasing revenue 9% on a constant currency organic basis. First, our AST segment. It continues to benefit from our core medical device customers growth. Over the past 3 years, we have invested more than $100 million to expand our global network, which has allowed us to grow with our customers. We are making an even larger commitment this fiscal year as a result of expanding global demand. Our plan is to invest over $110 million to grow AST capacity at a number of facilities around the globe, primarily in radiation technologies.

We remain committed to supporting our medical device customers worldwide with a technology-neutral sustainable set of sterilization offerings. We believe these investments will reap rewards for years and anticipate continued investment in capacity in the coming years. We generally expect these facilities to generate ROIC above our capital cost in a 3- to 5-year time frame. As you know, AST operating profit improved again this fiscal year, ending the full year at 40% EBIT margins.

Moving on to the Healthcare Specialty Services business. We experienced a very strong year, particularly in North America. Our instrument repair franchise and our outsourced instrument reprocessing business in North America both exceeded our expectations as customers see the benefit of STERIS solutions. Profit dollars improved 10%, and margins improved sequentially quarter-by-quarter as we leveraged the investments made earlier. We continue to believe that this segment can achieve mid-teen margins over time.

Our Healthcare Products segment also had a good year, increasing 7% on a constant currency organic revenue basis with solid growth across consumables, service and capital equipment. Revenue continued to benefit from products launched over the past 12 to 18 months, including our Celerity 20-minute biological indicator, V-PRO maX 2 and related V-PRO maX chemistries, SYSTEM 1 endo and new washers and sterilizers. We expect another year of robust new product sales in fiscal 2020, including the CLEANSUITE Ceiling Systems and [XU] operating room integration systems as well as our recently launched V-PRO s2, which offers compact size and shorter cycle time compared with prior generations. Operating profit dollars for Healthcare Products grew double digits, and margins improved 120 basis points to over 24%.

And finally, our Life Sciences segment grew annual revenue 5% on a constant currency organic basis versus last year's challenging comparisons. Consumable products led the way with a 7% increase over the prior year, with capital equipment and service growing low single digits.

During the fourth quarter, we moved our barrier products manufacturing to a new facility that will support our growth for many years. As a result of that move, some customers preordered inventory, driving barrier products consumable growth somewhat above normal levels in Q4. This will likely impact our growth rate a bit in the first half of 2020. Life Science continued to improve the bottom line with 60 basis points improvement in EBIT margin for the year.

All told, we ended fiscal 2019 with record adjusted earnings per diluted share of $4.89. Volume growth, improved margins and a lower-than-anticipated effective tax rate drove that improvement.

Now looking ahead to fiscal 2020. The underlying fundamentals of our business remain strong. We anticipate constant currency organic revenue growth of 5% to 6%, with currency impact approximately neutral to our revenue guidance. Within that revenue outlook, we are absorbing our restructuring plan, which reduces organic revenue by about $20 million in fiscal 2020. Margin expansion will likely be within our typical range, reflecting the benefits of our restructuring, which were somewhat offset by continued investments in the business.

We anticipate adjusted earnings per diluted share to be in the range of $5.28 to $5.43. For your modeling, we expect earnings to be split about 45% first half and 55% second half, which is consistent with prior years. We plan on an effective tax rate of 19% to 20% and interest expense to decline $3 million to $4 million in fiscal 2020 due to lower debt levels. As usual, our share count is assumed to be neutral in our guidance, with share repurchases roughly offsetting management equity grants. And to be clear, this outlook assumes no medical device excise tax to be in effect in our fiscal fourth quarter.

Capital spending is planned to be approximately $280 million in fiscal 2020, a meaningful increase from prior years. As I already mentioned, the primary driver is AST expansions. In addition, we do plan to continue spending capital to grow our outsourced instrument reprocessing business in the HSS segment. As a result of expectations for strong operating performance, somewhat offset by nearly $100 million of increased capital spending, free cash flow is expected to be approximately $300 million for fiscal 2020.

Fiscal 2019 was a great year for STERIS, with all our business segments meeting or exceeding our expectations. That does make for a challenging comparison in FY '20, but we are confident in our ability to sustain revenue growth in line with our long-term targets and continue our path in increasing earnings in 2020 and beyond. We believe that STERIS is better positioned than ever before, and we appreciate your past and continued support of your company.

We're happy to take any questions you may have. Julie, if you would open for Q&A.

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Julie Winter, STERIS plc - Senior Director of IR [5]

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Thank you, Walt and Mike, for your comments. Mike, if you would give the instructions, and we'll get started on Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And the first question we have will come from Dave Turkaly of JMP Securities.

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David Louis Turkaly, JMP Securities LLC, Research Division - MD and Senior Research Analyst [2]

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I just wanted to clarify something. You mentioned $110 million for investment. I think in the prepared remarks you might have said that, that was entirely for AST, but you also mentioned the Healthcare Specialty investment. So if that's true or if you want to, I don't know, break that out between them, I just wonder how many new centers would that be? And it says global. Are they primarily in the U.S., the AST build-out that you're doing? And are they new? Or are they just expanding existing?

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Walter M. Rosebrough, STERIS plc - CEO & President [3]

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We probably won't get into the exact details here, but it is multiple sites. It is split fairly well around the globe. So the U.S. makes up roughly half the business, and so the U.S. is roughly half of the expansion, but then the balance is around the globe. The earlier-on expansions are in the U.S. Some European and other parts of the world are lagging a little bit. But -- so in terms of dollars this year, it's probably more heavily weighted to the U.S. side but over dollars -- over a longer period of time because these projects don't end in 3 months. These are 12-, 18-, 24-month projects, and so the longer-term tails will be outside the U.S. But at a high level, we've done a lot of expanding, and we're continuing to expand more. And kind of the easiest way to think about it if we're growing high single digits or even mid-single digits, we have to build, effectively, 4 or 5 plants a year. Unfortunately, not all those are greenfield builds. Some of these are greenfield builds, but a number of them are adding a bit to an already existing plant. That's obviously much cheaper. So it's a combination of all those things that gets us to $110 million. That $110 million was specifically growth investment for AST. We also talked about roughly $100 million in total because we had growth investment in AST last year, the $100 million-ish in total capital spend, and that does include spending for the HSS plant. But it is [not for] plants, if you will. But that level of spending is -- pales in comparison to the $110 million of AST.

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David Louis Turkaly, JMP Securities LLC, Research Division - MD and Senior Research Analyst [4]

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Got it. And then on the -- you mentioned some of your targets for operating margin. But the Healthcare side was really strong, and I guess 24% is a nice level for the operating margins to come in. But I'm curious as to where -- I'm sorry, I think it was 28% this quarter. Where is that going? If you're looking ahead here, obviously, your biggest segment and a nice uptick in profitability year-over-year, I'm just curious if you have longer-term targets for that business alone.

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Walter M. Rosebrough, STERIS plc - CEO & President [5]

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Dave, I guess we've talked about this a number of times kind of generically, and I don't feel any different about that business than I do the others. There are puts and takes in that business. Sometimes mix has an effect if one -- if a roughly high-margin piece of the business is growing a little faster than the other or vice versa, you have a mix effect. But in general, we anticipate being more efficient with our resources over time and sharing some of that with our customers and keeping some of that for ourselves. So on average, we would hope to grow our profit a little bit faster than our revenue by doing that. And we don't have a target per se or an end point per se because we add things to it all along, and that changes the mix. But in general, our people know that we think we should get more efficient every year and pass on a piece of that efficiency to our customers.

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Operator [6]

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And next, we have Matthew Mishan of KeyBanc.

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Matthew Ian Mishan, KeyBanc Capital Markets Inc., Research Division - VP and Senior Equity Research Analyst [7]

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I guess first just a housekeeping question. Could you potentially quantify what the Brexit-related inventory build was in the quarter, where you saw it impact? And same token, the same thing for the preorder of the Life Sciences consumables.

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Walter M. Rosebrough, STERIS plc - CEO & President [8]

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Yes. Orders -- we expected a question on this, by the way. It's just part of the answer is we don't know what we don't know, and we thought that was worthwhile more in a conversation mode than in a discussion mode. But we had visibility to orders of magnitude $5 million of revenue or -- I'll call it inventory buildup by our customers. It's spread around, a fair amount in Healthcare Products business, so that -- I would say probably the bulk of it in the Healthcare Products business. But we also saw it in the Life Science business because you have pharmaceutical plants on both sides of the Pond, and there are barrier products on both sides of the Pond. So people that were concerned -- and then in AST. People concerned that they may not be able to get the goods either out of England into Europe or out of Europe into England or other places, they built their inventories somewhat. In those places where they told us about it and told us about it in advance, we have a pretty good visibility. So again, something on the order of around $5 million, we have good visibility. What we don't know is what we don't know. The supply chains are sometimes long. The hospital builds a little inventory, and then the -- a distributor builds a little inventory, and somebody else builds a little inventory. In AST, if a manufacturer is building inventory in anticipation in their warehouses and they want it sterilized ahead of time, we don't often have visibility to that. So our best guess is probably something in the $5 million to $10 million range, but it is a guess at this point in time. I don't think it's significantly greater than that.

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Matthew Ian Mishan, KeyBanc Capital Markets Inc., Research Division - VP and Senior Equity Research Analyst [9]

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Does $5 million to $10 million...

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Walter M. Rosebrough, STERIS plc - CEO & President [10]

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I'm sorry?

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Matthew Ian Mishan, KeyBanc Capital Markets Inc., Research Division - VP and Senior Equity Research Analyst [11]

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This is $5 million to $10 million including the preorder for -- ahead of the move with the barrier products?

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Walter M. Rosebrough, STERIS plc - CEO & President [12]

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Yes. That would be -- great question, yes. That would include that preorder.

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Matthew Ian Mishan, KeyBanc Capital Markets Inc., Research Division - VP and Senior Equity Research Analyst [13]

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Okay. Got it. And then the 5% to 6% organic revenue growth for next year, I'll give you credit. It's above where you started off the last couple of years at 4% to 5%, but it's also below where you're exiting, around 8%. As you kind of look at the segments, which areas do you feel confident growing above, which maybe do you feel confident growing below and some of the puts and takes around the 5% to 6%?

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Walter M. Rosebrough, STERIS plc - CEO & President [14]

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Yes. Matt, I'm not sure that we're going to talk about it that way. It is -- obviously, our IMS business has had 2 or 3 pretty solid years the last 2 or 3 years, but that came on the tail of getting beat up because we had a pretty significant miss 3 or 4 years ago. Assuming no significant shift in lost customers, then we feel pretty good about that business being above the 5% range certainly. AST has been very hot, hotter than our expectation. We don't know how much of that is inventory build or growth or churn, and it takes us a little while to get those kind of facts and figures. But all things being equal, we'd probably expect it to be above the average. The Life Science capital -- Life Science capital has been a big grower the last couple of years. And as we had mentioned in our last call, the Life Science capital side probably is not -- it's not going to go 20%, 30% a year the rest of time. It has seem to kind of level off into some modest growth levels, but it's staying at much higher levels than it was 3 years ago. So we're comfortable with the level it's at. I don't think we consider that a superfast grower at this point in time. I think at a high level kind of that gives you kind of the order of magnitude. Mike, do you have any other comment?

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Michael J. Tokich, STERIS plc - Senior VP, CFO & Director [15]

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Yes. Matt, one of the other things that we are going to experience in FY '20 is about a $20 million negative impact from our restructuring activities. So those manufacturing facilities that we identified in the third quarter restructuring, we're going to lose about $20 million of revenue. So that's going to be absorbed in that 5% to 6%.

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Matthew Ian Mishan, KeyBanc Capital Markets Inc., Research Division - VP and Senior Equity Research Analyst [16]

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Okay. That's fair. And then on the EPS growth, you guys typically -- you're typically a double-digit growth company. That's what you generally expect. But when you look at the range that's coming in at 8% to 11% for the year, what are you -- why are you being cautious on the low end there?

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Walter M. Rosebrough, STERIS plc - CEO & President [17]

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We're on the backside of 2 really big years of EPS growth. If we do the numbers we have here and we hit our churn -- if we do the revenues we have in this place, we feel pretty comfortable in the 8% to 11%. And this is all inorganic -- organic, excuse me, growth. And so when we say we're double-digit growers in EPS over long periods, we include the inorganic component.

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Matthew Ian Mishan, KeyBanc Capital Markets Inc., Research Division - VP and Senior Equity Research Analyst [18]

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All right. And then just last question I want to sneak in. On the AST and the dynamics of the growth there and the $110 million of expanded capacity, it seems pretty clear here you're outpacing your customer volumes in the quarter, also overcame the Sterilmed headwind. Does this growth have anything to do with customers reacting to a competitor issue?

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Walter M. Rosebrough, STERIS plc - CEO & President [19]

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I don't think there's any consequential change there. There's always been churn in the business. Sometime we lose some. Sometime we win some. Sometimes it's more public than other times. This is one of those times when things are a little bit public. But they have a significant network of ethylene oxide plants in North America, and so the first movement from that plant, obviously, would go to their additional plants. We have picked up a little bit, but I wouldn't call it consequential.

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Operator [20]

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And next, we have Jason Rodgers with Great Lakes Review.

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Jason Andrew Rodgers, Great Lakes Review - VP [21]

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I wonder if you could talk about the tariff impacts this quarter, what your outlook is there as well as just, in general, price and raw material costs going forward.

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Michael J. Tokich, STERIS plc - Senior VP, CFO & Director [22]

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Yes, Jason. For the full year, in fiscal '19, we experienced about $1 million in the combination of labor and tariffs. We are anticipating approximately the same amount in FY '20 with no material costs in either FY '19 or FY '20.

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Jason Andrew Rodgers, Great Lakes Review - VP [23]

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And just to follow up on the AST question, the EO facilities. Is there any risk there as far as elevated emissions issue that your competitor faced potentially impacting you?

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Walter M. Rosebrough, STERIS plc - CEO & President [24]

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Well, there's always a question of regulatory, I'll call it, intervention in any of our businesses. As you know, I mean we're in the healthcare business, and we are quite accustomed to dealing with all kinds of regulatory agencies. A big, big piece of our business across all of our businesses is sterilization. And sterilization by definition requires the use of products that are -- let's say -- they kill bugs. They kill biological entities, which means we're a biological entity. So there's a risk if we don't handle it right, that there's an issue. We do handle it right. We've been doing this for 40 years. We do feel that we -- I mean we know we meet the requirements as they stand today. We are generally speaking ahead of the requirements because many places in the world do not require the same level of scrutiny that are in the U.S. and Western Europe. And we build our factories or sterilization facilities in a way that it meets the highest levels of standards, both in safety of our people and for emissions. And so the answer is we think we're in a good spot. We are always looking for ways to improve it, and there's always a risk in all of our business that there's a regulatory impact. Having said that, we don't think there's anybody in the planet better positioned in sterilization and general analysis sterilization to be able to handle any consequential thing the regulators choose to do. So we're comfortable in our position.

I will say, in addition, it's worthwhile to note that roughly half of all devices that have to be sterilized, which is essentially anything that touches your bloodstream, from adhesive bandages to orthopedic implants and -- I shouldn't say orthopedic implants here because that's a radiation product, but to pacemakers, let's say, so across a wide range of products, roughly 50% of them have to be sterilized with gas of some sort, and ethylene oxide is by far the preferred methodology. And I mean by far, by 99% to 1% kind of numbers. And if we stopped doing ethylene oxide around the world, we would stop healthcare around the world in a few weeks.

So I think all parties -- all the parties working on this are looking for the same thing. We want safety for our workers. We want safety for the patients, and we want safety for the environment. And everybody's working on the same thing, and I'm confident we'll find the proper ways to handle that.

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Jason Andrew Rodgers, Great Lakes Review - VP [25]

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That's helpful. And if I could just squeeze one more in. The outsourcing project in HSS, I think the last estimate was about $10 million in revenue in fiscal '20. Is that still the case?

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Walter M. Rosebrough, STERIS plc - CEO & President [26]

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Additional revenue or additional -- yes, we did a little better than that this year. We would hope to do at least that this coming year.

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Operator [27]

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And next, we have Larry Keusch with Raymond James.

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Lawrence Soren Keusch, Raymond James & Associates, Inc., Research Division - MD [28]

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Maybe just to start with on the AST expansion. I guess the question, Walt, is -- it sounded like from your comments that this is going to be a multiyear process. You see a lot of opportunity out there. Obviously, to grow at the rates you want to grow at, you need to continue to expand your capacity. So are we -- is the best way to think about this is that we're entering into a multiyear period of what I'd call elevated CapEx spending?

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Walter M. Rosebrough, STERIS plc - CEO & President [29]

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Larry, that's an excellent point, and your deduction is correct from our earlier comments that it takes a couple years to do this. This $100 million or so this year is not the end of the tail, so we'll see some elevated capital spend over the next several years. Has to be an elevated revenue and profit to go with it, and that's the key point.

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Lawrence Soren Keusch, Raymond James & Associates, Inc., Research Division - MD [30]

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Correct. Okay, perfect. Just a couple of other quick ones. I couldn't help to notice, but on the backlog, you were on a sequential basis down about $30 million and, excuse me, closer to, I think, $60 million in the total backlog, about 10 percentage points higher than you typically are. So any thoughts behind, again, that reduction in backlog this year that seems a little bit larger than the last couple of years?

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Walter M. Rosebrough, STERIS plc - CEO & President [31]

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Yes. Larry, it's -- our ending backlog is kind of similar to previous years, up bit on -- up a bit growth, if you will. So we can't -- what we think is kind of a normal ending backlog. We did have, as we mentioned in Q3, we did have some shipments that moved from Q3 to Q4, and a lot of that was already billed. We had extraordinary January, February this year, and so that led to a reduction in backlog. But we don't see any -- go forward, our view of the pipeline is consistent with what we've said in the past.

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Michael J. Tokich, STERIS plc - Senior VP, CFO & Director [32]

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And Larry, this is Mike. The -- [one thing] is I agree with you sequentially, but we've been building backlog for the first 3 quarters, and we did flush a lot of that out. But if you look year-over-year, in Healthcare we are still up 16%. So again, to Walt's point, we are starting the year at what we think is a strong backlog, strong position.

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Lawrence Soren Keusch, Raymond James & Associates, Inc., Research Division - MD [33]

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Okay. That makes sense. Two last ones for you guys. Just given the -- some of the comments around some perhaps accelerated order activity in the fiscal fourth quarter, how should we be thinking about the cadence for the 1Q? I know you talked about sort of the gating for the first half versus second half, but just any thoughts on -- that you could provide on the 1Q. And I guess lastly, for you, Walt, just M&A. Obviously, the balance sheet is in great shape, below 2x leverage asset valuations feel like they are still elevated. But any sort of commentary around the landscape out there would be great.

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Walter M. Rosebrough, STERIS plc - CEO & President [34]

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Yes. Larry, the only area where we have kind of comfort on the timing of the orders, the inventory [fill] of our customers is in the barrier products. We do -- we'll expect to see that because -- work its way out probably in a quarter or 4 or 5 months because that was clearly done as a result of our plant expansion, the plant -- or the plant change. We have a beautiful plant for that facility now, and that will work its way out relatively quickly. So that one we're comfortable is in there. And it's -- that sits in the guidance that we gave in terms of the 45-55.

In terms of the "Brexit numbers," that's a tougher one because, as you know, supposedly we're Brexit-ing in October, but supposedly we were Brexit-ing in March. And so I don't know if our customers will work their way down and build up again in October if they don't have visibility or if they're going to just hold it until they get to October and run normal. That one is less clear to us. In our planning, we did not take that in any significant account; that is, we took it across the year, if you will. So in our planning, we're assuming it just kind of works its way out over the full fiscal year as opposed to any onetime thing. As we get closer to October, we'll adjust that planning, obviously.

So that's -- I think that responds to the first question. The second question is we do have -- as I mentioned before, we have a pretty robust pipeline right now in BD opportunities. The issue is opportunities don't always turn into actualities, a, in the time frame you like or, b, sometimes other people think things will work more than we do. And then sometimes owners decide to continue [down], and so we have the normal uncertainties. But we have a robust pipeline, and we clearly are not financially constrained in making any significant view of what we want to do.

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Operator [35]

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And next, we have Chris Cooley with Stephens.

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Christopher Cook Cooley, Stephens Inc., Research Division - MD [36]

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Congratulations on a great last fiscal year. Just 3 quick ones for me, and maybe the first a little bit of a [nip]. I think the only thing I can kind of question the fourth quarter was in Life Science capital. And I know, Walt, you alluded to this in your prepared remarks. You had 21.5% growth last year, just phenomenal. But we've now declined 2 consecutive quarters on a year-over-year basis. Are there maybe alternative channels that you can start to address or categories that you might want to simulate here? Just trying to kind of relevel set expectations for Life Sciences capital. And I've got 2 quick follow-ups.

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Walter M. Rosebrough, STERIS plc - CEO & President [37]

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Chris, on Life Sciences capital, your point's well taken. The good news is if we look at our backlog it's still sitting in that $60 million-kind-of range, and so that's where we like to have it. And as you know, versus 3 years ago we're way up in Life Science capital. So this is not an area of concern we have. We do not believe this is a superfast-growing area of our business, but it is a nicely profitable piece of the business, and the service that goes along with it is nice. It is almost, I think, on the slower-growth side going forward. And to your latter point, we're always looking at different opportunities in all of our businesses. And the reason we break our business as we do is those managers it doesn't make any difference to them if AST is growing or not. They need to grow their business, and they're looking for opportunities in that space.

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Christopher Cook Cooley, Stephens Inc., Research Division - MD [38]

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Appreciate that. And then secondly, just on the free cash flow guidance for this year, it's essentially 10% of the top line, about a 3.5%, 4% free cash flow yield today, so very healthy. But just a little bit curious there. As you step up into what you alluded to as a multiyear expansion when we think about AST, how does this impact the other businesses that, I'm assuming, also require growth capital but maybe just can't candidly compete as well internally when you look at operating margin contribution? Help us kind of square your comments about stepping up the CapEx level for what I'm assuming is essentially AST right now versus other investments that might benefit the growth of STERIS longer term via the other segments.

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Walter M. Rosebrough, STERIS plc - CEO & President [39]

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Yes. Sure, Chris. I mean, first of all, our #1 -- our capital allocation philosophy hasn't changed. Our #1 issue is we don't intend to cut our dividend. We generally plan to grow it roughly in line with the growth in profitability and cash flow, which tend to marry each other. The second thing is to invest in the businesses. And so if we were going to slow any capital spending down as a result of cash needs, it would be not on the current businesses we have. It would be on the M&A side, which is next in line. We do not in any way face capital crunch at this point in time. We like investing into businesses because we know them really well, and we tend to do what we think we're going to do in those as opposed to M&A, which we generally do where there's a little more risk. So we are not in any way in a capital-constrained situation in our operating businesses. If anything, we are pushing them to find opportunities to invest more in their businesses. There's a thin line between investing and spending, and we want to -- governments tend to call spending investment. We tend to call investments investments, and we expect to get a return on those -- on that, it's all cash, but on that spend. But there's no capital constraint in any of our businesses for growth capital per se. There is obviously constraint on operating expenses and other expenses in the business as there should be, but if it can generate good returns, we're happy to invest it across the line in our businesses.

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Michael J. Tokich, STERIS plc - Senior VP, CFO & Director [40]

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And Chris, just to dig a little deeper there. We maintain -- our maintenance CapEx is around $130 million, and that's been pretty stagnant for the last couple of years. So we are not starving any of our segments by any means from a capital standpoint. So that allows us to for next year about $150 million in total CapEx growth.

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Christopher Cook Cooley, Stephens Inc., Research Division - MD [41]

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Understood. Well, keep on investing rather than spending. And then I guess just lastly for me. When you look at the Healthcare Specialty Services, you got up into the double digits on a year-over-year basis, so you're 11% approximately op margin, approximately 15%, 14.6% to be precise. So when we think about moving that forward now, in your prepared remarks you talked about a mid-teens grower -- I'm sorry, a mid-teens margin. Is this now pretty consistent or will it be back -- when you think about the underlying base business plus outsourcing, is this really something that we can think about now as kind of a consistent double-digit organic grower and then those margins lifting sequentially from here? Or do I need to think about maybe something else there as kind of a counterbalance?

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Walter M. Rosebrough, STERIS plc - CEO & President [42]

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Yes. Chris, it really depends on the growth rates. Typically, in the outsourcing business, you do have to invest, and that investment can be both capital and expense investment. You've seen that before. I mean it's true basically in all service businesses. But the outsourced can come in kind of big lumps, and if a lump comes along, it will look a lot like the AST business used to look for us 10 years or so ago. 10 years ago, every time we build an AST plant, we saw a margin decline. And today, we have enough of them, but it just doesn't push the margins. It does push them in that plant. That plant falls, but the other -- so if we have a number of things that come along in the HSS business where we're making investments, we could see a temporary decline. We don't expect that to be a permanent situation, and we expect over time for those to grow. And we've mentioned we do believe this is a mid-teens kind of business. We put that marker out there when we were running 3%. So we thought that was kind of an aggressive marker. We think that's a reasonable marker. If we get to mid-teens, then we'll be thinking about 20%. But we'll worry about that when we get there.

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Operator [43]

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(Operator Instructions) Next, we have Mitra Ramgopal of Sidoti.

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Lalishwar Mitra Ramgopal, Sidoti & Company, LLC - Healthcare Sell Side Analyst [44]

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Just 2 questions. Walt, I was just wondering given the expansion on the AST side in terms of going global, I was wondering if there are any other areas you think you might be looking to grow beyond the U.S. even more, for example, maybe opportunities on the instrument reprocessing side.

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Walter M. Rosebrough, STERIS plc - CEO & President [45]

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Yes. We clearly want to look global in all of our businesses. Some businesses are more attuned to it, if you will. I mean you kind of walk through -- the AST business is quite a global business. It's roughly 50-50, U.S. and OUS, and we expect that to continue. If anything, OUS may grow a bit faster. When it comes to the Life Science business, it is also largely a global business because our Life Science customers tend to be global entities. And so we do face them globally, if you will. We're organized globally. The sales force is organized globally, and so that is very much a global business.

In the Healthcare space, it is -- it's not that it's U.S. It is country by country in large case, and so you have to organize around the countries. And it just so happens the U.S. is a big one, and it's the one we started. So we still are quite a bit stronger in the U.S. than other places. Interestingly enough, our OUS business -- if you look at it organically, our OUS business has historically grown faster than the U.S. business. It's just we keep buying things that have the same kind of footprint we do, which is heavily U.S. So the inorganic side has grown faster in the U.S. than OUS, with the exception of Synergy, and Synergy did change our footprint a fair amount because we do outsourcing largely in the U.K. and also in Europe.

So -- but at a high level, yes, we're attuned in any market where that -- if you use the market loosely, any country where they're accepting of the type of services that we do, and we're looking for ways to amend our products and services such that they're more acceptable outside the United States.

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Lalishwar Mitra Ramgopal, Sidoti & Company, LLC - Healthcare Sell Side Analyst [46]

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Okay. No, that's great. And then just going back to margins. Again, we saw improvement across all the segments. And I know aside from incremental volume and pricing, et cetera, you highlighted, I think expense management on the Life Sciences side and I think some improvement productivity on the HSS side. I was just wondering if you can just provide a little more color on that in terms of if we should be expecting more of the same in fiscal '20.

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Walter M. Rosebrough, STERIS plc - CEO & President [47]

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Yes. I mean generally speaking we expect -- there are certain areas we know we have opportunities to reduce expenses, and we go at those significantly in a way where we're targeting expense management. In general, we just expect as -- there's variable costs and fixed costs. The variable costs you have to take active management to cause them to be reduced. The fixed costs you have to actively manage them not to grow. And we do work at that, but like all things, there's some growth -- fixed isn't really fixed. It's just the way we kind of think about it, so we have to manage that. But in general, our expectation is when we're doing things that if we grow we should become more efficient as we grow. So our costs, particularly the fixed costs, should grow less quickly than the variable costs. And that's kind of at a high level how we manage.

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Operator [48]

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And next, we have a follow-up from Larry Keusch of Raymond James.

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Lawrence Soren Keusch, Raymond James & Associates, Inc., Research Division - MD [49]

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Yes. Mike, just one quick follow-up here. So the guidance, as you indicated, for fiscal 2020 does not include any impact of the medical device tax potentially coming back in your last fiscal quarter. To the extent that it were to come back at, again, that's sort of 2.3%, can you remind us sort of how it was running for you guys in the past just to help calibrate some thoughts around that?

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Michael J. Tokich, STERIS plc - Senior VP, CFO & Director [50]

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Yes. Larry, so as you said, we do not anticipate it coming back in our fourth quarter. And what we had seen in the past is about $3 million negative impact on a quarterly basis. So that'll give you at least from a modeling standpoint what our thoughts are.

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Operator [51]

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Well, showing no further questions at this time. We will conclude our question-and-answer session. I would now like to turn the conference call back over to the management team for any closing remarks.

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Julie Winter, STERIS plc - Senior Director of IR [52]

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Thanks, everybody, for joining us and for your continued support of STERIS. We look forward to seeing many of you out on the road in the coming weeks.

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Operator [53]

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And we thank you, ma'am, and to the rest of management team, for your time also today. Again, the conference call is now concluded. At this time, you may disconnect your lines. Thank you. Take care, and have a great day, everyone.