Mirion Technologies, Inc. Q2 FY2023 Earnings Call

Greetings, and welcome to the Mirion Technologies Second Quarter 2023 Earnings Conference Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Alex Gaddy, Vice President of Investor Relations. Please proceed.

Good afternoon, everyone, and thank you for joining Mirion's Second Quarter 2023 Earnings Call. Reminder that comments made during this presentation will include forward-looking statements, and actual results may differ materially from those projected in the forward-looking statements. The factors that could cause actual results to differ are discussed in our annual report on Form 10-K and quarterly reports on Form 10-Q that we file from time to time with the SEC under the caption Risk Factors and in Mirion other filings with the SEC. Quarterly references within today's discussion are related to the second quarter ended June 30, 2023. The comments made during this call will also include certain financial measures that were not prepared in accordance with generally accepted accounting principles. Reconciliation of those non-GAAP measures to the most directly comparable GAAP financial measures can be found in the appendix of this presentation accompanying the call today. All earnings materials can be found on Mirion's IR website at ir.mirion.com. Joining me on the call today are Larry Kingsley, Chairman of the Board; Tom Logan, Chief Executive Officer; and Brian Schopfer, Chief Financial Officer. Now I will turn it over to our Chairman of the Board, Larry Kingsley. Larry?

Thanks, Alex, and good afternoon, everyone. Thank you all for joining our quarterly earnings call and for your continued support for Mirion. This morning, we published solid Q2 results that we believe position us well for the remainder of 2023. We continue to see consistent backlog growth, which is the most encouraging forward-looking indicator for the rest of the year and entering 2024. Our second quarter was highlighted by better-than-expected top line performance from both operating segments. This reflects a continuation of the trends we reported on over the last couple of quarters. And we expect this to bolster momentum heading into the second half. Margin performance was within our expectations for the quarter as we began gaining greater price cost traction and moving beyond the supply chain disruptions. Additionally, we anticipate the unfavorable geographic and product mix impacts to ease in the third and fourth quarters. Cash flow and net working capital efficiency are not yet achieving targeted performance expectations. But I'm deeply familiar with the plan, and I have confidence in the team and the approach. I'll get into more detail later in the call, but the focus remains on improving inventory turnover, increasing collection velocity, and other material flow and transaction efficiency improvements. The company's robust backlog, improving execution, and favorable vertical market dynamics bolster our confidence. Speaking on behalf of the full Board, we have confidence that management is executing well against the appropriate set of priorities for the business. Lastly, it's worth noting that as of mid-July, the prior private equity controlling sponsor has fully exited their position in Mirion. With that, we have removed another overhang on the stock. So I'll now pass the call over to our CEO, Tom Logan. Tom?

Larry, thank you, and good afternoon, everyone. To get things started, I'd like to begin by thanking my Mirion colleagues for their very hard work during the second quarter. Let's get right into the details around our results, beginning with some highlights from the quarter. First, Q2 was another solid quarter of order growth. We booked approximately 9% adjusted order growth compared to the same period last year and expanded our backlog position for the fourth consecutive quarter. Importantly, we continue to see strength from smaller recurring customers and have a high degree of engagement on larger Technologies projects. Second, we outpaced our internal expectations for total company revenue for the quarter, delivering organic growth of nearly 8.5% compared to the same period last year. The Technologies group led the way with organic growth of over 9%. Third, free cash flow was $2.3 million in the second quarter. While this is admittedly a meager sum, it was consistent with our expectations for both the quarter and the year. Cash flow was challenged by higher interest expense and net working capital dynamics for the quarter. Finally, we've updated our financial guidance for 2023. We increased and tightened our revenue ranges and have raised our adjusted EBITDA expectations, bringing our new midpoint towards the upper end of the previous range. We also updated adjusted free cash flow guidance to the range of $45 million to $75 million for the full year. Now before delving into our quarterly financial results, I'd like to highlight our first half orders performance and some of the trends we're seeing in our end markets. If we turn to Slide 4, our first half order growth was 6%, driven by strong performance from labs and research, defense, and diversified industrials, offset by tough year-over-year comps within both the nuclear power and nuclear medicine businesses. In the Medical segment, we continue to see market strength. Radiation therapy quality assurance order growth has been robust, driven by positive results from our national account marketing strategy and the investment in our European sales center. In dosimetry, we continue to see stable growth and good customer engagement with our digital platform as we prepare to launch our third generation of Instadose technology in 2024. And finally, within nuclear medicine, we continue to enjoy macro tailwinds, including new diagnostic and therapeutic radiopharmaceutical approvals and growing patient procedural volume. In the Technologies segment, we remain encouraged by market dynamics as well. As a reminder, we delivered over 17% order growth in the segment in the first half last year, so comps were tough. In the nuclear power business, we see improving dialogue within our installed base, coupled with a strengthening new build cadence. Both labs and defense were also strong in the first half, with notable contributions coming from the North American lab space and European defense markets. Overall, our demand environment is favorable, and we expect strong first half order performance to support expectations for the second half and beyond. Let's now flip over to Slide 5 to discuss our second quarter results in more detail. As previously noted, we delivered almost 8.5% organic revenue growth on a consolidated basis in the second quarter supported by solid organic growth in both segments. On the Medical side, we added the recent momentum and delivered nearly 7% organic revenue growth during the quarter. Performance was spurred by continued strength in our radiation therapy quality assurance end market with encouraging growth internationally in both the legacy Sun Nuclear and CIRS phantoms businesses offsetting a slowdown in domestic demand within the business. Additionally, Q2 was positive for the Technologies segment as we delivered over 9% organic revenue growth. Segment performance here was strong across geographies and products. A couple of final highlights I'd like to make before Brian jumps on. First, as we transition to the second half of the year, operational excellence lies at the very top of my agenda with a clear focus on both free cash flow and margins. On cash flow, our primary opportunity is to improve inventory turns. During the pandemic and subsequent global supply chain dislocation, I directed the organization to build up strategic inventory reserves as a mitigant to the frequent and often unpredictable supplier de-commits we experienced. Now we see greater stability across our supply base and can come off this war footing to a significant degree. Consequently, we have bolstered our industrial planning capabilities from both an organizational as well as a process standpoint. Our near-term goal is to drive inventory turns to our peer group median of roughly 4x. And to get after this aggressively, we've organized tiger teams to drive improvements in demand planning, production scheduling, and distribution planning. While the impact is not yet reflected in our numbers, I'm confident we will see meaningful results in the back half of the year. On margins, we've seen compression as a result of incremental public company costs, the transitory impact of the SIS integration, and the price-cost effects of our backlog. Public company costs have now been lapped and are stable to down. We're making great progress on the SIS integration and expect it to be margin neutral within our planning horizon. Finally, we're beginning to see the aggressive price action taken in 2022 turn into greater price realization as it flows through backlog while simultaneously seeing a reduction in the inflationary rates of labor and material inputs. All of this is reflective of my view that we will continue our long history of margin expansion in the quarters and years ahead. Let me now pass the mic over to our Chief Financial Officer, Brian Schopfer. Brian?

Thanks, Tom, and good afternoon, everyone. To begin my commentary, I'll ask you to please turn to Slide 6 to take a deeper look at the second quarter results. Total company revenue grew by 12.2% in the quarter, while adjusted EBITDA was up 4%. Quarterly revenue was $197.2 million, and organic growth was 8.4%. Adjusted EBITDA was $44.3 million, with margins contracting 170 basis points to 22.5%. As expected, our Q2 margin profile was what we saw in the first quarter. Margin rate headwinds, as anticipated, stemming from the SIS acquisition and incentive compensation true-up in the prior year as well as a product and geographic mix impacted margin performance. We saw lower Medical software as a percent of total sales and a higher international and distribution channel contribution again in Q2. We expect improvements in the second half as these mix headwinds begin to abate in the third quarter and benefits from cost-out initiatives are expected to materialize. Our price-cost impact was positive in the quarter with a 4% price contribution but dilutive on an overall margin rate basis. Let's now dive into more detail around our segment performance during the quarter, starting with the Medical segment on Slide 7. Medical revenue was up 1.8% during the quarter, with organic growth of 6.9%. Medical top line performance in the second quarter was better than expectations. As previously mentioned, growth in Medical is expected to moderate in the third and fourth quarters versus the average of 15% that we've seen over the last five reporting quarters. As a reminder, we completed the divestiture of the Biodex physical rehab business, which impacted reported revenue by over 5% in the quarter. Medical adjusted EBITDA margin was 32.8% in the quarter, a 40 basis point contraction compared to the same period last year. Medical margin performance was impacted by a higher international revenue mix within our radiation therapy quality assurance business and a lower overall percentage of software revenue. This was offset by the divestiture of the Biodex rehab business. Moving on to Slide 8 in the Technologies segment. Technologies revenue grew by 18.5% in the quarter with organic growth of 9.3%. Revenue performance was led by broad-based strength in our labs and research end market as well as continued nuclear power momentum across North America and Europe. Technologies adjusted EBITDA was $35.2 million, representing growth of 6.7% in the quarter. Adjusted EBITDA margin contracted 310 basis points to 27.2%, driven by product and geographic mix and a larger contribution from the SIS acquisition. SIS impacted adjusted EBITDA margins in this segment by 120 basis points during the quarter. Additionally, we saw a negative impact of approximately 100 basis points year-over-year from lower incentive compensation in the prior year related to a lower true-up onetime true-up related to our nuclear projects business in France during 2Q '22 that did not repeat this year. Turning now to Slide 9. Adjusted free cash flow was $2.3 million during the quarter. As we've discussed on prior calls, cash flow performance, primarily net working capital efficiency, is not at the standard we expect. Albeit slightly slower than planned, we are seeing the shorter-term actions put in place beginning to take hold, especially in our inventory positions. We're continuing to invest in our sales and operations planning functions globally, both in terms of process and talent. This is a journey, but we are well down the path of progress and have good confidence in the approach and plan we've set in motion. Net leverage finished the June quarter at 3.6x. Looking ahead to the second half of the year, we remain committed to achieving our leverage target of 3.1x or lower with an execution-focused mindset. Finally, let me walk you through our updated 2023 financial guidance on Slide 10. As Tom noted earlier, we have raised and tightened our top line guidance. We are expecting revenue growth of 8% to 10% on a reported basis with 6% to 8% organic growth. Organic revenue growth is expected at mid-single digits from Medical, high-single digits from Technologies, expected between $175 million and $185 million, with adjusted EBITDA margins between 22% and 23%. Adjusted free cash flow guidance is $45 million to $75 million for the full year. We continue to expect a positive contribution of net working capital at the midpoint of guidance, with the majority expected in the fourth quarter. Overall, I'm really proud of the Mirion team for delivering another solid quarter. We still have work to do on cash, but I'm confident we are headed in the right direction.

Brian, thank you. Before opening things up for Q&A, there are a few items I'd like to reiterate as we conclude our prepared comments this afternoon. First, top line performance was ahead of our expectations for the second quarter, supported by our robust backlog position and favorable demand dynamics across our end markets. Second, our margins were tighter in the second quarter compared to last year, but performance was within our expectations. We're expecting P&L dynamics to improve in the second half as previously discussed. Third, we remain highly focused on improving our free cash flow and continue to expect net working capital to be a source of cash for the full year. Finally, we are confident heading into the back half of the year and have updated our guidance accordingly. Our end markets are healthy, demand is strong, and we are executing well. I look forward to updating you with our third quarter results this fall. But let me now pass it over to Alex to open things up for Q&A.

Thank you, Tom. That concludes our formal comments for this afternoon. Operator, let's go ahead and start the Q&A session.

Our first question comes from Citigroup.

So maybe just stepping back, bigger picture. Can you give us an update on what you're seeing in your M&A pipeline today? And more broadly, how you're thinking about M&A potential going forward over the next few quarters and into next year?

Sure. Let me cover that. Very little has changed actually. In our last call, I think we updated our view that our M&A pipeline continues to be vigorous and of great interest to us. And that we are extremely committed to bringing leverage down to what we've guided consistently, which is at or below 3.1x at the end of the year. We remain confident that there is an opportunity for us to essentially execute on some smaller potential deals over our planning horizon. So not falling within any specific timing bucket, that allows us to again strengthen some of the strategic markers that are of great interest to us while simultaneously managing leverage in a downward arc overall. And we remain confident in our ability to do that and continue to be quite active in our outreach from an M&A standpoint.

Okay. That's helpful color, Tom. I appreciate that. And then maybe just digging into cash flow and working capital dynamics. I know you talked about net working capital still expected to be a source of cash for the year and focused on getting inventory turns down. But can you maybe give us some color or specifics on the actions and processes that you're implementing that give you confidence in improving free cash generation into 2H and beyond?

Yes. Let me start, and then I'll invite Brian to chime in here. But I've been doing this a long time. I've been in the role here for almost 20 years. And I think with any industrial technology business, working capital in general is something that requires a degree of pressurization within the organization. And the dynamic that always exists is the interplay between carrying cost of working capital, particularly inventory, versus the economic impact of a potential stock-out in a lost order overall. I think historically, we've been very good at managing that dynamic. But as I stated in my scripted comments, what we learned as we went through this post-pandemic supply shock was that supplier behavior became more erratic. And we, as others did, experienced last-minute supplier de-commits and order cancellations and the like, which clearly had a knock-on effect in certain segments of our business overall. And so to mitigate that through the organization, to build strategic inventory buffers to avoid, again, the economic toll of potential stock-out situations, we really began to accommodate and generate a better understanding of the likely future dynamics of our supply chain. Today, what we're seeing is a continued evolution of favorable direction. I think we have a much better handle overall on where our supply chain risk lies. And we can take a much more targeted approach to how we think about strategic buffer in inventories. But this gives us the ability to really focus the organization then on tightening what had been a looser envelope that I had implemented again during this post-pandemic supply shock period. The way we're getting after that is very conventional. It's a ground game, where it is a combination of improving the quality, the caliber of demand planning, flowing that through procurement strategies and production scheduling activities and ultimately into our distribution resource planning. We're attacking all of those things on a multidimensional basis. Again, as noted in the comments, we have mobilized broad-based teams to really escalate the focus beyond the normal cadence. And we're confident that all of this will lead to a positive effect over the back half of the year, and that's what gives us the confidence in the overall cash flow dynamics for the full year.

The next question comes from Joe Ritchie with Goldman Sachs.

So just on Technologies for a second. And great to see the kind of orders accelerate and the growth the first half of the year. When you think about the cadence of the revenue profile for the second half of the year, you guys had like outsized shipments in the fourth quarter of last year. I'm just curious like whether there's anything we should think about just because of the way things kind of played out at the end of last year.

Yes, I think I'll take this. I think that our expectations are really around a very robust third quarter, Joe. We don't really give quarterly guidance, as you know. But I think organically, we see a very good third quarter and double-digit type third quarter. And then the fourth quarter, kind of in line with the overall guide for the year.

Got it. Yes. Go ahead, Tom.

Joe, I want to add that when we consider the market dynamics, order intake, backlog coverage, and so on, we feel very optimistic about the year-over-year performance in Technologies. Our position here is strong.

Our coverage, to Tom's point, continues to be kind of mid- to high-single digits, better coverage than where we sat last year. So that gives us confidence in where we're sitting in that segment.

Yes. And so maybe you guys can elaborate on what's driving the strength in Technologies. So I saw you guys pick up the organic growth expectations basically from mid- to high-single digits. And then there's a lot of concern, I guess, across the industrial channel. I'm not talking about your business specifically around just destocking that's occurring. And I'm just curious, just any comments that you can overlay on the portion of your business that sells through independent distribution and what you're seeing from a channel perspective as well?

Yes. I would say that, considering the unique mix of our business, we have historically shown very little cyclicality. We view ourselves as an a-cyclical company. In our Technologies operating segment, the key underlying dynamics in the nuclear markets are important. We believe the health of the installed base is strong across all major markets, and the level of engagement and activity supports this view. Additionally, we are observing an increase in engagement related to new build activity, which we expect to contribute positively to the market strength in the future. The defense sector has been a significant topic for us, especially in light of the ongoing war in Ukraine, which we anticipate may lead to increased demand for our civil defense solutions and NATO military gear. So far, we've seen strong performance, with first half order growth of 28% in defense and diversified industrials. For example, we secured a $10 million European civil defense order in the second quarter, highlighting this trend. Finally, in the life sciences area, particularly labs and research, we experienced a remarkable 30% order growth in the first half. This demand is driven not only by traditional government and university-funded labs but also by new applications like mining, where our solutions significantly enhance productivity. Currently, we are not witnessing any early signs of a reversal in these positive trends or changes in customer behavior. Given our historical performance in these market segments, we remain confident as we move into the latter half of the year and beyond.

The one thing I'd add maybe, Joe, to that is we don't typically sell through distribution channels that stock our products, right? They tend to be ordered, customer specific, application specific, et cetera. So the risk that we've shopped product in the channels and now people are waiting to sell that through, that's not something that's historically how our channels have worked, specifically in the Technologies segment but even more broadly there. So I think that's something else to think about is that just isn't the business model on the Technologies side at all.

Yes. That's super helpful color from both of you. If I could just squeeze one more question in, just on margins in Technologies and specifically around SIS. Can you maybe just talk about high level how the integration is going? And then also as you kind of think about the margin impact, you called out both mix and SIS this quarter. How is that expected to trend going forward?

Yes. First of all, regarding the integration, we are very pleased with its progress. I often compare it to our experience with Biodex, which was a similar asset in terms of size both at the top and bottom lines. That integration took us two years, but it is now contributing positively to the company's margins. We approached that integration with a more traditional method, involving factory closures and other changes. In this case, however, we are deliberately maintaining some costs as we invest in digital platforms for the medium to long term. When looking at the Technologies side of our business, we have very little software as it serves merely as an enabler, which requires time to develop. We did reduce costs in June, but that won't be seen in the second quarter results. We anticipate those reductions will benefit us in the latter half of the year and into 2024. Tom mentioned that we aim to achieve a margin profile that meets Mirion standards over time. However, we want to be strategic because this asset is valuable across our portfolio. While we could expedite cost reductions, it might negatively impact our long-term growth, so we are choosing to be patient and continue investing.

The next question comes from Chris Moore with CJS Securities.

Maybe, Brian, you could just talk a little bit more specifically on pricing, kind of the cadence. Are there any potential wildcards out there later in fiscal '23 from a price cost perspective?

Yes, we continue to model price-cost neutral across the company. I believe there is an opportunity for us to perform better than that. We'll see how the latter half of the year plays out, but as we address inventory, we are also mindful of costs. We expect a 4% price increase this year across the board, applicable at both the segment and company levels, so I don't anticipate any surprises there. We are confident in our pricing strategy and the efforts our teams have made in the markets. We are continuously assessing where we can potentially increase prices in both segments. The Technologies team has already taken steps in the second and third quarters, and we expect those changes to reflect over time. Overall, we feel good about our current position.

Got it. Very helpful. Dosimetry orders were up, I think, 2% in the first half. Is there a point perhaps second half of '24, maybe a little further out, when Instadose will likely pick that pace a little bit? Or visibility there is still not where you'd want it to be?

Chris, what I'd say is that we're certainly not guiding '24 right now. But if you look historically at how we have guided the market growth in that business overall, at mid-single-digit growth or better. Certainly, our digital story here, Instadose is a key component of that overall. And as we commercialize the third generation of this technology, we certainly expect some related uplift overall. So I think it does move the needle. But to be clear, we're not calling the shot at this point.

I understand. That's helpful. Regarding new nuclear plant construction, it takes time before we see its impact on the income statement. However, can you highlight any tangible progress that indicates we are further ahead now compared to 12 months ago?

Yes. I mean, the main thing here is, firstly, as it relates to new build projects that we have in backlog today, those, by and large, are evolving on schedule and consistent with expectations. So really nothing that I would add there. But what I would say is that as it relates to new project-related activity, we've been very busy, again, very actively engaged with our global customer base and continue to be very encouraged by the activity that we're seeing. We expect that this will further bolster a nuclear market that really has come alive. We think it's a market that has legs. And so we're happy to have the position that we have right now.

Thank you. At this time, I would like to turn the call back to Mr. Tom Logan for closing comments.

Well, ladies and gentlemen, let me just conclude by firstly thanking you for your time and attention today and, as always, the support for our company. Today, we have noted a number of key things. We feel good about our market dynamic. We feel good about how we are translating that into order intake and top line performance. We understand that margins and cash flow are a show-me story, but this is a very familiar story to us, to me, in particular, over my 20 years of leadership of this company. And as stated throughout the call, we have a high degree of confidence in our ability to deliver the results that we're guiding and very much look forward to posting you on the results as we report our third quarter in the fall. And so until then, again, thank you for your time and attention, and I wish you all enjoyment of the last vestiges of summer, and we'll very much look forward to our next call.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time, and thank you for your participation, and have a great day.