Earnings Call Transcript - GEHC Q1 2023

Operator, Operator

Good day, ladies and gentlemen, and welcome to the GE Healthcare First Quarter 2023 Earnings Conference Call. My name is Olivia, and I'll be your conference coordinator today. As a reminder, this conference is being recorded. I would now like to turn the program over to your host for today's conference, Carolynne Borders, Chief Investor Relations Officer. Please proceed.

Carolynne Borders, Chief Investor Relations Officer

Thanks, Olivia. Welcome to GE HealthCare's First Quarter 2023 Earnings Call. I'm joined by our President and CEO, Peter Arduini; and Vice President and CFO, Helmut Zodl. Our conference call remarks will include both GAAP and non-GAAP financial results. Reconciliations between GAAP and non-GAAP measures can be found in today's press release and in the presentation slides available on our website. During this call, we'll make forward-looking statements about our performance. These statements are based on how we see things today. As described in our SEC filings, actual results may differ materially due to risks and uncertainties. And with that, I'll hand the call over to Peter.

Peter Arduini, President and CEO

Thank you, Carolynne, and good morning, everyone. I'm very pleased by the solid performance we delivered in our first quarter as an independent company. The momentum we demonstrated last year has continued, and I'd like to thank our teams across the world for their continued dedication to executing on our precision care strategy. We delivered strong 12% year-over-year organic revenue growth with contributions coming from all of our segments, driven by increased fulfillment, improved pricing and commercial execution. We expanded adjusted EBIT margin year-over-year through price and lean initiatives focused on cost and operational effectiveness and we're on track to achieve our margin expansion goals for the year. We continue to monitor customer prioritization of capital purchases of our products, and we are cautiously optimistic given resilient end market demand. Supply chain challenges are improving, giving us line of sight throughout the remainder of the year. We continue to invest organically to deliver long-term growth, demonstrated by the 13% year-over-year increase in R&D in the first quarter, in line with top line growth. In addition, we acquired Caption Health and IMACTIS, which provide us access to new technologies, markets and clinical capabilities. I also want to highlight today's declaration by our Board of a $0.03 dividend for the first quarter of 2023. This reflects our confidence in the durability of our cash generation, a disciplined capital allocation strategy and our commitment to returning value to shareholders. Overall, the momentum we see in our business gives us confidence in our ability to deliver on our full year 2023 guidance. With that, let me hand the call over to Helmut to walk through our financials and business segment performance.

Helmut Zodl, Vice President and CFO

Thanks, Pete. Turning to our financial performance. For the first quarter of 2023, revenues of $4.7 billion increased 8% year-over-year and grew double digits at 12% organically. This was primarily driven by strong product growth across all segments. Adjusted EBIT margin improved year-over-year to 14.1%, growing 150 basis points on a stand-alone basis versus last year. Margin was up to the higher volume, which was partially offset by the mix of products versus services. In addition, we were able to mostly offset inflation and play investments through our pricing and productivity actions. But we are pleased with our margin performance during the quarter. There is room for more improvement. We have lean action plans in place to continue to expand margins further through volume, price and productivity initiatives across the company. Adjusted EPS was $0.85, up 35% on a stand-alone basis, driven by our strong revenue growth as well as margin expansion efforts. Free cash flow of $325 million was down $46 million, as expected based on the spin-related items, which I will discuss shortly. Total company book-to-bill, which, as a reminder, is a calculation of total orders divided by total revenue was 1.01x. This was driven by strong revenue growth across all our segments, led by recurring PDx sales. We continue to see customers invest in solutions that drive better clinical insights and productivity across the U.S., China and Europe. Moving to revenue performance. We grew 12% organically year-over-year. Foreign exchange was a headwind of 4% to revenue growth during the quarter. On a reported basis, product revenue increased 12% year-over-year driven by PDx sales with strong demand from increased procedures. Services revenue grew 1% versus the first quarter of 2022. Our strong product growth will translate to services growth as we go forward. From a regional perspective, we are pleased to see all regions growing with China up double digits. We are pleased with our margin performance this quarter. As we continue to focus on improvements in delivery, price and productivity. We delivered a positive sales price for 4 consecutive quarters with growth in all segments. These efforts combined with our productivity initiatives enabled us to generate year-over-year and sequential gross margin expansion. We also continue to see supply constraint easing with spot price and logistics costs down sequentially and year-over-year. The actions we've taken to broaden our supply base coupled with the continuous application of lean principles has helped us to requalify almost 8,000 parts since COVID began. This has led to the lowest number of red flag parts since the first quarter of 2021, enabling us to deliver for patients and customers, which is our top priority. As we look at our platforming initiatives, we have made good progress in CT with increased standardization of components across the portfolio. We've identified opportunities for simplification in sourcing, purchasing and manufacturing. We are in the process of implementing similar changes in MR. Following our spin-off from GE, we are on track with planned exit of TSAs, with approximately 40 exited to date. We remain focused on reducing G&A costs for example, with real estate expense and IT costs. Moving forward, we see opportunities to expand margins through additional actions for instance, in logistics with greater shift from air to ocean and greater platform standardization. Before I get into the segment commentary, let me remind you that in 2023, approximately $200 million of recurring stand-alone costs will be impacting our segment EBIT margin rates. These costs are generally allocated based on the revenue and did not exist in 2022. Turning to imaging. We saw strong organic revenue growth, up 12% year-over-year. This was led by MR as well as molecular imaging and CT, driven by supply chain fulfillment improvement and growth in revenue from MPIs. We expect continued high growth throughout the first half of 2023 that will normalize throughout the rest of the year. Imaging demand is expected to remain healthy, supporting top line growth. Segment EBIT margin of 7.7% declined 120 basis points year-over-year as planned investments and mix outweighed higher volume. Productivity and pricing initiatives more than offset inflation. We expect sequential margin rate improvement as we move throughout the year. Through lean efforts in imaging, we initiated a rolling 13-week schedule to maximize factory output and customer satisfaction. This will improve fulfillment as well as working capital. Overall, we expect steady growth in demand in 2023 with a number of drivers, including a continuous backlog of procedures, expanding indications for high-end diagnostic exams and new therapies requiring precision imaging. Moving to ultrasound. We saw strong organic revenue growth, up 10% year-over-year, led by cardiovascular, general imaging and women's health products. This was driven by MPIs and improving supply chain fulfillment with few electronic component shortages. While we expect growth to normalize as we move throughout the rest of the year, we continue to see strong customer demand in both hospital and other care settings. Segment EBIT margin of 24.1% was up 50 basis points year-over-year. We realized benefits from productivity and price initiatives, along with volume growth. This enabled us to offset headwinds from inflation and planned investments, including the Caption Health acquisition. We expect the EBIT margin rate will remain generally in line with the prior year. We continue to focus on patients and customer-centric innovation, especially digital and artificial intelligence solutions. Moving to Patient Care Solutions. Revenue was up 11% organically, driven by volume and price. This resulted from greater backlog fulfillment as supply challenges eased, particularly for electronic components. We benefited from dual site production for highly constrained products. Revenue was also driven by the launch of key MPIs contributing to increased volume, such as CARESCAPE Canvas and the B100 series of acute care monitors. PCS backlog remained strong, which will contribute to revenue growth into the future. We expect quarterly revenue dollars to remain relatively consistent throughout 2023. PCS margins of 14% increased 490 basis points compared to the first quarter of last year, driven by productivity, price and volumes. These are partially offset by inflation as well as planned investments. Productivity in the first quarter was driven by favorable logistics and lower spot price. We expect EBIT margin rate to normalize throughout 2023. Moving to Pharmaceutical Diagnostics. We saw strong organic revenue growth, up 19% year-over-year, driven by price, increased procedures and the stabilization of supply. We expect continued revenue growth for the year based on favorable comparisons in the second quarter and the fourth quarter. Segment EBIT margin of 27.8% declined 70 basis points year-over-year, mainly driven by raw material inflation and planned investments. This was partially offset by price and volume and productivity which also drove full 80 basis points of sequential improvement. Next, I'll walk through our cash performance. During the quarter, we generated $325 million of free cash flow. This was down $46 million year-over-year, impacted by $85 million of incremental post-retirement benefit payments and $42 million of interest payments, which were not in our 2022 actuals. Without these new cost-related items, year-over-year free cash flow would have been positive for the quarter. Working capital improved year-over-year primarily driven by collections and inventory efficiency. We have leveraged lean to implement a daily inventory management system. In the first quarter, we achieved solid results from controlling and better predicting inventory inputs and outputs with shorter lead times and improved revenue conversion cycle. As a result, we saw faster inventory turns and over $100 million of improvement in intra-quarter inventory. Strong cash flow generation will allow us to pay down debt and invest organically and inorganically in our business. We are pleased to initiate a dividend with opportunity for growth over time. Our dividend philosophy is driven by prudent capital planning as well as a strong revenue and earnings growth potential and a robust free cash flow profile. Our balance sheet remains strong with significant financial flexibility. Let's move now to our outlook. For the full year of 2023, we are reaffirming our guidance. We continue to expect year-over-year organic revenue growth in the range of 5% to 7%, with strong organic growth in the first half of the year versus the second half. In line with seasonality, we expect revenue dollars to grow first half to second half. Our current view is a foreign exchange headwind of less than 1 percentage point for the year. We continue to expect full year adjusted EBIT margin to be in the range of 15% to 15.5%. This would represent an expansion of 50 to 100 basis points over the 2022 stand-alone adjusted EBIT margin of 14.5%. We also expect to see an increase in adjusted EBIT margin rate from the first half of the year to the second half, driven by higher volume and productivity benefits. We expect R&D investment to grow at the higher end of the 2023 organic revenue growth range. Our guidance for adjusted effective tax rate remains in the range of 23% to 25%. Our full year 2023 adjusted EPS is unchanged in the range of $3.60 to $3.75, representing 7% to 11% growth. This compares to 2022 stand-alone adjusted EPS of $3.38. We continue to expect free cash flow conversion to be 85% or more for the full year. Our cash flow outlook assumes that the legislation requiring R&D capitalization for tax purposes is repealed or deferred beyond 2023. The free cash flow impact of this legislation would represent up to 10 points of free cash flow conversion for the year. For 2023, we expect capital expenditures to be in the range of $350 million to $400 million. I'd like to add that our second and fourth quarter cash flow will be impacted by interest payments as roughly 75% of our interest expense related to our long-term debt is paid out in these quarters. Given this interest payment timing, we expect lower cash generation in the second quarter versus the first quarter. Cash flow will be substantially higher in the second half of the year relative to the first half due to typical cash seasonality and annual timing of supplier and compensation payments. In closing, it has been a strong start to the year, and we are confident in reaffirming our guidance.

Peter Arduini, President and CEO

Thank you, Helmut. Before turning to Q&A, I want to provide an update on some exciting focus areas in our business. In Imaging, we're energized about the developmental advancements we're making with photon counting CT technology for improved spectral and spatial resolution, reduced radiation and enhanced contrast to noise ratio of tissue at a molecular level. This step change in technology will help provide clinicians with more capabilities to significantly increase imaging performance across a variety of care pathways. We believe we're on the right path towards the industry's second generation of photon counting technology with a deep silicon approach for even better resolution and clinical results. This technology will expand our imaging capability into high pitch helical and gated cardiac imaging, which are just a few of our important milestones in development. During the quarter, we also announced our acquisition of Caption Health, which expands access to Artificial Intelligence powered ultrasound imaging guidance for novice users. We're utilizing AI to provide real-time expert guidance to the user, and this helps us obtain diagnostic images providing advancements for patient care outside the typical hospital-only setting. And while we'll be starting with cardiac care pathway, we expect to extend this to other specialties in the future through continued R&D investment. In our Patient Care Solutions business, we announced the FDA 510(k) clearance of our CARESCAPE Canvas monitoring platform. This interoperable solution can flex based on individual patients' needs for precise care. And the platform also offers continuous upgrade capability, so hospitals can adopt new technologies at their own pace for efficient fleet management across the different care pathways they serve. This series of MPIs represent initial steps towards realizing mission-critical infrastructure transformation that leverages the Edison platform and enables artificial intelligence in patient monitoring. In neurology, we've been watching the emergence of disease-modifying therapies for Alzheimer's and the positive impact on patients. With the success of these advancements, we anticipate the need for more imaging. GE Healthcare is one of the only companies that has a full suite of products and solutions to support the entire Alzheimer's patient journey. And this includes our Vizamyl diagnostic agent and PET scanners, which can be used to confirm diagnosis and the MRI systems to monitor throughout the therapy. I'm also pleased with the initial progress that we've made since forming our science and technology operations led by Dr. Taha Kass-Hout, our Chief Technology Officer. Specifically, we're driving cloud adoption to deliver on our digital innovation strategy and also building out these capabilities into our device portfolio. Last week, we met with many customers and collaborators at the Healthcare Information and Management Systems Society, the HIMSS Meeting, where we featured our growing portfolio of digital and AI innovations to help increase operational efficiencies, improve diagnostic confidence and support early interventions. In closing, I want to reiterate that we're encouraged by the strong results we delivered in the first quarter. Our margin improvement initiatives are taking hold, and we see ongoing opportunities to drive productivity and growth. Our backlog remains solid, and we're confident that we are investing in the right areas to drive long-term innovation. And with the reaffirmation of our guidance for the year, we're demonstrating our commitment to delivering for customers and shareholders. Lastly, our team continues to be passionate about making a difference for patients. We recently held our first Patient Care Week. Our employees had the opportunity to experience the real impact of our products, solutions and services and how they're driving and delivering better outcomes for patients and also access to care. This is a great example of the cultural transformation taking place at GE Healthcare. With that, we'd like to open it up for questions.

Carolynne Borders, Chief Investor Relations Officer

Olivia, we're ready to open for questions.

Operator, Operator

And our first question comes from Ryan Zimmerman with BTIG.

Ryan Zimmerman, Analyst

Sorry, I was on mute there. Congrats to everyone. I want to start by noting that the book-to-bill ratio came in at 1.01. I believe orders were down about 3%, specifically 2.7%, from last year, but please correct me if I'm wrong on that, Helmut, as it's just a summary number from the GE deck from last year. How do you view the seasonality of this dynamic and the book-to-bill ratio as we move through the year?

Helmut Zodl, Vice President and CFO

Yes. Ryan, I think, let me probably remind you the calculation of the book-to-bill is orders over revenue. So our first quarter book-to-bill at 1.01 is really reflecting our 12% revenue growth. So with improved fulfillment and especially our PDx sales. In PDx, we have a 1:1 ratio of book-to-bill. The backlog, maybe if I'll cover that a little bit, grew sequentially. So our RPO is now at around $14.5 billion, which is up 1%, and we saw positive orders growth. We don't disclose order growth in details, but we saw positive order growth in the quarter. And our total backlog is close to $19 billion in this. Again, this was a very strong quarter in delivering top line revenue growth. At the same time, our RPO is slightly up on a year-to-year basis.

Peter Arduini, President and CEO

And Ryan, I would just add, I think we had a strong quarter in Q1 of last year. The numbers came in this year right on track. We'll expect that to continue to grow. And again, just to emphasize Helmut's point, when you have a high performance on something like a flowable product like PDx and stuff, it fundamentally is kind of a net neutral one-to-one transfer through. But the team delivered what we needed to deliver, and we're on track here to what we believe we need for orders to grow throughout the year.

Ryan Zimmerman, Analyst

Got it. Very helpful. I want to ask about the improvement in the diagnostic pipeline and its impact on the procedural environment. We heard similar comments from some med tech peers last week. Pete, I would like your perspective on the environment, especially from a diagnostics point of view. You're likely observing it through imaging volume, so how do you see the balance of the year from a diagnostic screening perspective?

Peter Arduini, President and CEO

Yes, Ryan, it's a really interesting question. And obviously, we have a certain lens into it. But I think if you step back when I'm out on the road talking to customers, and I've been with quite a few recently, you're just seeing that almost any type of therapy, whether it be in the musculoskeletal, whether it be in the cardiac, oncology, everything is heavily gated by some level of diagnostic to choose a better decision whether it be an implant, some type of interventional device to precisely fit that patient. And so particularly in the imaging world, we're still seeing significant demand and procedures for customers, meaning that their backlogs are still quite long. And again, we don't think this is necessarily a blip. We think that with the rise of many new therapies whether it be TAVR or whether it be pharmaceuticals that require more follow-up and measurement, just the need for what we do to make sure that you're getting the optimization and outcome, but also managing cost is there. So we see it quite strong. And it's interesting, it's not just a U.S. phenomenon. I mean, we're seeing this in most markets around the world.

Helmut Zodl, Vice President and CFO

Yes, maybe I'll add a little bit. I think we're spending a lot of time with our customers, especially devices and digital solutions, we were just at HIMSS in the last week, a lot of discussions, how our devices can really help drive productivity to reduce that, I would say, challenge on the backlog and the shortages on personnel that some of our customers are having. That's really a key focus of our customer, which drives demand.

Anthony Petrone, Analyst

Congrats on a strong first quarter here. Maybe, Pete, a couple for you here. I'll just pick off where Ryan left off here. Maybe rounding out just the discussions with hospital customers, what are you hearing on the capital spending front? We've heard some, in certain cases, still very bullish outlook, certainly for imaging, but on certain high-ticket items, there seems to be a little bit of friction. So maybe just your thoughts on the CapEx environment. And then I'll have a couple of follow-ups.

Peter Arduini, President and CEO

Yes, Anthony. I would say not a lot has changed since we reported even in our fourth quarter from that standpoint. I think we're encouraged by kind of the steady recovery of the global procedures, which is really the underpinning of this, which says, if you have a lot of patients that need procedures, they need planning, they need evaluation done and you don't have enough equipment that drives demand. And again, it's not always new sockets. It may be software and upgrades to your fleet to bring new capabilities. So we see that happening. And if I just go around the world, China has strong growth. Obviously, COVID for a couple of years, things opened up, a lot of demand there. Our intercontinental markets, Southeast Asia and LatAm were seeing actually similar strong growth as specific countries and areas, Indonesia, different areas in Southeast Asia and Latin America, investing. Western Europe is quite stable. I think the continuation of some of the sick funds investments that took place coming out of COVID is really just starting to deliver on that equipment. And the U.S. is, look, since COVID, people have been prioritizing capital. I mean, so that's no new news for us. But again, what we keep an eye on is what they're deciding to put it against. And I think with nursing costs starting to flatten out, you're seeing a little bit more of, I would say, positivity on that spend. That being said, we think we're going to be in a capital prioritization kind of focus throughout this year, which is why we're cautiously optimistic.

Anthony Petrone, Analyst

That's helpful. And then follow-up, one for you, Pete, and a quick one for Helmut on margin. Intrigued by the comments on Alzheimer's disease and maybe just a little bit of a description is, is that something that is driving demand now? And when you look out, how long do you think that tailwind to the business can be with just new drug therapies coming to market? And then quickly for Helmut on margin, when we think about the $200 million of stand-alone costs, just sort of the outlook on when you can perhaps see leverage on those new costs that were brought into the business.

Peter Arduini, President and CEO

Yes, Anthony. Look, on the Alzheimer's point, no, I don't think we're really seeing any impact on demand to date. But when you look at what can come, what the pipeline looks like we think there's going to be larger demand. I'll even pull the lens back a little bit further. It ties into part of Ryan's question as well. I think, look, bigger picture, imaging capabilities and diagnostics used to kind of manage how devices are executed, but probably even more importantly, expensive pharmaceutical injectable therapeutics, how they're utilized, how they're titrated, how they may be dosed and the follow-ups on potential complications really seems to be a potential kind of norm in the future. So if you think about this case, neurosciences, if you think about in oncology with theranostics, if you think in cardiology with different follow-ups for structured heart or heart failure, we see that happening. And so we'll see how that plays out. But like in our case, where we make the actual tracer, Vizamyl for amyloid-beta plaque detection and quantification, really the only one that has that type of product that actually even colors that and separates it out. It hasn't been reimbursed. And so we believe once the therapies get reimbursement like in other therapy areas, the companion diagnostics also do, that's what will enable some of the growth. And so I'm optimistic, like most things, it will take a little bit of time. But over the next few years, I think there's going to be some interesting growth opportunities associated with that match up.

Helmut Zodl, Vice President and CFO

Yes. So Anthony, I think around this $200 million of stand-alone costs, in 2023, we expect an estimated $200 million of those recurring incremental expenses. Those are primarily for support functions, so it's IT, treasury, IR and so forth. And these costs, they are not in our segment margins. They were not in our segment margins in 2022. We're allocating them in 2023 based on the revenue very generally. So I want to be sure that, that is well understood. And to your question, when we will see leverage against those one, to me, this is really dependent on how quickly we are exiting our TSAs. You saw me speak, we exited 40 TSAs in the first in the quarter. Here, we have more TSAs to exit that will take us into 2024. So I expect we'll see leverage against this $200 million of incremental recurring spin costs as we go into 2025 and '26, as we have fully exited on the TSA side and can really build our own infrastructure.

Jason Bednar, Analyst

Congrats on a very nice start to the year. Maybe I'll start with organic growth. Just as we peel apart the components of the 1Q organic growth, are you able to quantify how much of that 12% may have come from pure price? It looks like you're calling out pricing tailwinds in each of the 4 segments. I'm just curious if we should be thinking in the area of 1% to 2%, 2% to 3%, etc., when we think at the corporate level? And then is that a sustainable figure as we look to future quarters? Or would you point us to maybe upward or downward bias in the pricing?

Peter Arduini, President and CEO

Yes, Jason, it's Pete. I'll share my thoughts and see if Helmut wants to add anything. I believe this is a really strong outcome. All four of our segments performed well. From a growth perspective, volume was clearly the main factor driving this. We managed to work through our backlog, along with some sales and installations, particularly in our ultrasound business, as well as developments in PDx and the Injectable business. I would estimate that price contributed around 2% to 3%, while the majority of the growth came from pure volume and uplift.

Helmut Zodl, Vice President and CFO

Yes, I would like to add a bit to that, Jason. As Pete mentioned, this is our fourth consecutive quarter of positive sales pricing. We anticipate a 2% to 3% increase in 2023, and in the following years, that may level off to about 1% to 2%. However, the most crucial aspect is the value we are delivering to our customers with those products. Our focus extends beyond price; we are also concentrating on expanding our gross margins. As we introduce new MPIs, we are closely examining both price increases and the resulting margin improvements. We have numerous initiatives in place regarding BCP and platforming that will assist and support these efforts.

Peter Arduini, President and CEO

Yes, Jason. We are collaborating with the agency and expect to make progress in the first half of this year unless there are additional questions. We are currently active in markets outside the United States, primarily in the EU. Regarding our focus on Portrait Mobile, it represents a new direction for us. We have not been a company that relies on award-based monitoring, making this our first venture into that area. We've already received positive feedback from various customers about enabling continuous monitoring. One major shift we are anticipating post-COVID is the increased focus on continuous monitoring for oxygen, carbon dioxide, and respiratory metrics. Given the staffing shortages, there is a significant opportunity to manage patient care more effectively by directly alerting caregivers rather than conducting sporadic checks. We are actively pursuing this initiative and will provide further updates in the upcoming quarters, and we are optimistic about its potential. Yes, it's a great question. And I would say it's a pretty good mix between the two. Certain geographies have different characteristics. As you could imagine, in an inland growing China market, it's heavy on new sockets. In Europe, believe it or not, we're trying to see a little bit more new than old because there's more outpatients opening up centers. In the United States, it's probably a combination of 60-40 installed base or fleet renewals with new growth. And the new growth typically is tied to probably more of an outpatient imaging or tied to an ambulatory surgical center type environment. Thank you. So look, in closing, we're very pleased with the strong start to the year, and we see significant opportunities ahead of us as we continue to innovate and solve some of these big challenges that we've talked about that our customers face in delivering high-quality care in and outside the hospital in a very cost-effective way. And we look forward to keeping you updated on our progress. Thank you for joining our call today and I'm sure we'll see many of you at some upcoming conferences. Thank you.

Operator, Operator

Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.