STERIS Q3 2022 Earnings Call Transcript

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February 8, 2022

There are 8 speakers on the call.

Operator

Good day, and welcome to the STERIS PLC Third Quarter 2022 Earnings Conference Call. All participants will be in a listen only mode. After today's presentation, there will be an opportunity to ask questions. Please also note that this event is being recorded. I would now like to turn the conference over to Julie Winter, Investor Relations.

Operator

Please go ahead.

Speaker 1

Thank you, Matt, and good morning, everyone. Speaking on today's call as usual will be Mike Tucic, our Senior Vice President and CFO And Dan Crescio, our President and CEO. And I do have just 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 expressed written consent of STERIS is strictly prohibited.

Speaker 1

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, and on our website. In addition on today's call, non GAAP financial measures, including adjusted earnings per diluted share, Adjusted operating income, constant currency organic revenue growth and free cash flow will be used. Additional information regarding these measures, including definitions, 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.

Speaker 2

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 Q3 performance. For the quarter, constant currency organic revenue increased 9%. Growth was driven by organic volume as well as 100 basis points of price. Acquisitions added $333,000,000 to revenue, which is broken down by segment in the press release tables.

Speaker 2

To assist you with your modeling within the Healthcare segment, of the approximately $210,000,000 in acquired revenue, about 60% is consumable revenue from both Key and Cantel Medical. We passed the 1st year anniversary of the Key Surgical acquisition in mid November. So this quarter, Key Surgical's revenue is split between organic and inorganic. Gross margin for the quarter increased 90 basis points compared with the prior year to 45.1% as favorable productivity pricing and acquisitions We're offset by higher material and labor costs. We continue to face increased material labor costs, which totaled about $10,000,000 in the quarter.

Speaker 2

As we look at the Q4 of the fiscal year, we expect increased pressure on material labor of approximately $20,000,000 About twice as much as we anticipated just 1 quarter ago. For the full fiscal year, we anticipate absorbing approximately $45,000,000 And unplanned material and labor costs, all while continuing to serve our customers and deliver a record year of performance. EBIT margin for the quarter was 24 percent of revenue, an increase of 40 basis points from the Q3 last year. R and D expenses increased. And as anticipated, we are seeing operating expenses such as travel and sales and marketing costs return, Somewhat limiting EBIT margin growth.

Speaker 2

The adjusted effective tax rate in the quarter was 21%, Higher than last year, but in line with our expectations. We now expect the full year tax rate to be approximately 21.5%, reflecting year to date actuals and our expectations for the Q4. Net income in the quarter increased to $213,300,000 Earnings per diluted share were $2.12 Our balance sheet continues to be a source of strength for the company. At the end of the quarter, cash totaled $359,100,000 We continue to focus on debt repayment as evidenced by our leverage ratio At the end of the Q3, below 2.6 times. Year to date capital expenditures totaled $214,500,000 While depreciation and amortization totaled $319,300,000 Free cash flow for the 1st 9 months was 300 $300,000 As anticipated, this is declined from the prior year due to costs associated with acquisitions and integration of the Cantel Medical acquisition and higher capital spending year over year.

Speaker 2

I will now turn the call over to Dan for his remarks.

Speaker 3

Thanks, Mike, and thanks again to everyone for taking the time to join us today. Fiscal 2022 is shaping up to be another record year for STERIS. Our year to date results have been strong despite headwinds related to supply chain and inflation that are impacting both revenue and profit. In particular, growth in our AST segment remains very strong with 21% constant currency organic growth year to date. Healthcare has also rebounded nicely with 13% constant currency organic revenue growth in the 1st 9 months And record backlog of $382,000,000 at the end of the quarter.

Speaker 3

Life Sciences consumables have stabilized As anticipated and have contributed 5% constant currency organic revenue growth for the segment in the 1st 9 months. The capital equipment backlog in life sciences has also continued to grow to a record 117,000,000 As our backlog in Healthcare and Life Sciences suggests, the underlying demand for our products remains very strong. Dental revenue was about flat in the quarter, impacted by a slower than expected recovery in patient volumes. We do anticipate that, that revenue in the Dental segment will begin to rebound in the Q4. The integration of Cantel It's progressing ahead of our expectations as we indicated last quarter.

Speaker 3

We expect to exceed our cost synergy targets by about $10,000,000 And we are now approximately $35,000,000 in total cost synergies in fiscal 2022. Reflecting our strong performance to date, we are increasing our constant currency organic revenue outlook to the high end of our previous range and now anticipate approximately 11% growth for fiscal 2022. We are also increasing our earnings per diluted share outlook And now expect earnings to be in the range of $7.85 to $7.95 or $0.10 above the high end of our prior outlook. We do have a few known headwinds

Operator

in the

Speaker 3

Q4. We completed the divestiture of our renal business, which will reduce both revenue by about $45,000,000 and diluted EPS by about $0.05 in the quarter. In addition, we expect supply chain inflation to be incrementally worse by about $10,000,000 sequentially as Mike discussed. We do anticipate that we can offset some or all of those headwinds with higher cost synergies from the Cantel integration and continued operational improvements. However, we are leaving some room on the downside of our earnings range to reflect the continued uncertainty.

Speaker 3

All said, we are very pleased with where we stand today and the underlying strength of our diversified business. I want to thank all of the associates at STERIS for their hard work and continued dedication to serving our customers. We look forward to updating you all with our progress in the future. I'll now turn the call back over to Julie to open up for Q and A.

Speaker 1

Thanks Mike and Dan. Matt, if you give the instructions, we can get started on Q and A.

Operator

Thank you. We will now begin the question and answer session. Matthew Mishan with KeyBanc. Please go ahead.

Speaker 4

Hey, good morning and congratulations on a really great year to date So far, my first question is on the progression of organic growth. If I'm modeling it correctly, I'm coming in somewhere in the 4th Quarter around 5%, which would be a sequential deceleration. How should we be thinking about that in terms of procedural environment and then also how should we be taking into account, your ability to shift On Healthcare Capital Equipment Backlog, given the really the massive number, you have in orders Versus maybe difficulty in supply chain and getting those extra customers?

Speaker 3

Yes. I think the issue on the 5% is that the comps get tougher in terms of what we were looking at in Q4 of last And we've also baked in what we believe is some slowdown that we saw In January and continuing into some of February in terms of procedures as it relates to omicron, in particularly across the U. S. So we believe we've got that appropriately factored into our expectations. In terms of the capital equipment, I mean we're At this point, we're almost halfway through the quarter.

Speaker 3

And we have in our model forecasted that we're providing An assumption that there is going to be some holdback of equipment that won't go, just due to timing, But it's not an issue that we expect from an availability standpoint. It's more of an issue of some extent our customers' appetite to receive that equipment within the quarter. Nonetheless, I think what we stated before, there was about somewhere around a $20,000,000 Increase in backlog that we would have attributed to deferral or supply chain issues and things of that nature, I don't think, Matt, that we'll flush that out this quarter. I think it would be unreasonable to expect that in the current environment, but we'll carry that backlog forward into the Q1 of next year.

Speaker 4

Excellent. And then on to the operating margin, I mean, again, record operating margin in a Difficult environment. How should we be thinking about the offsets, you guys have had to the inflationary impacts? As I look at the corporate costs, the corporate costs or the other costs, as well as SG and A, did come down significantly From 2Q into 3Q, are those the Cantel synergy starting to be realized? And are they maybe coming in a little bit faster Than they were previously than you had previously thought.

Speaker 2

Yes, Matt, this is Mike. So yes, we did anticipate that we are Going to get more cost synergies and you are exactly right. Those are going to show up first in the corporate side, as we have taken The opportunity to reduce the redundancy of the corporate costs, reduce the redundancy of the CEO, CFO. So that's where you're actually seeing Those cost synergy savings and as Dan spoke earlier, we anticipate overachieving those cost synergies in this fiscal year by about $10,000,000 Some of that has already been reflected through the Q3. There'll be a couple of single digit $1,000,000 that will still come through in the Q4.

Speaker 2

But all in all, that is very favorable to us. The other thing that we're seeing and I think we're like everybody else As you know, our operating expenses have been bouncing around, especially around travel. We were anticipating more travel In the Q3, which didn't happen, so you're seeing that little bit lower operating expenses in total.

Speaker 4

Okay. So there was nothing really transitory in those numbers that would necessarily bounce back significantly into the Q4 and we're sort of At a good run rate on some of those other costs?

Speaker 2

Yes. For the most part, I mean, the only variance that I would See, being out there is, we are starting our Q4 is the new year from a calendar year from a benefit standpoint. So you will see Some benefits costs that are normally higher, but year over year those should be equal. And then the other thing is at the end of the day, Where does the management bonus occur? And if there is an overachievement, obviously, you will see that also reflected in the 4th quarter.

Speaker 4

Understood. Thank you.

Speaker 2

Yes. You're welcome, Matt.

Operator

Our next question will come from Chris Cooley with Stephens. Please go ahead.

Speaker 5

Good morning, everyone, and congrats on a great quarter and what looks to be a great setup going into next fiscal year. I know it's a little bit early for fiscal the next fiscal year guide, but just maybe with broad strokes as we look at the business, Kind of following on Matt's initial question there, capital in particular in healthcare really has stepped up Over the last several years and you do have a record backlog that you just alluded to won't pull through all the way here in the fiscal 4Q. Could you just help us think about kind of the end market there? Do we see a step up in the Kind of baseline growth rate for healthcare capital going forward, is that a function of replacement, more efficiencies? Or is this something that we should really think about normalizing, kind of reverting back to those historic levels of growth on the health Care capital side as we get out sometime in mid year by or at least by mid year next fiscal year.

Speaker 5

And I've got a quick follow-up.

Speaker 3

Sure, Chris. This is Dan. So what I would say is there is some part of the backlog build that we're seeing now that pent up demand on replacement, things that just didn't happen for At the same rate for 6 or 9 months during the early 1st year or so of COVID. There is some element of that. However, what I would say is the capital spending we're seeing from large hospital systems, in particular across the U.

Speaker 3

S. And as well as surgery and things of that nature is unprecedented right now. And we're well positioned with a really strong portfolio of capital equipment In life sciences and then also in our surgical business and our IPT business. And I think we're probably winning More than our fair share at this point in terms of our performance in the market. But the market is very hot and I don't know that I've ever seen this level of investment from our customers that we're seeing today.

Speaker 3

And I don't see it slowing in the short term anyways.

Speaker 5

Thank you. Appreciate that color. And then just kind of shifting gears to the Life Science segment. I Continue to be impressed with the operating margin contribution that we see there as well as with AST. Can you just speak about thematically where you're seeing both of these portfolios Product mix shifting towards and really what I'm getting at here, do we is this a stair step where we're kind of Flattening out here at these record levels for a little bit, but as the mix continues to shift, you have a chance for another step up in margin?

Speaker 5

Or do we need to think about The operating margin contribution from here really becoming more a function of volume through the plant expansion at the AST side as we just think about it thematically going forward. Thanks so much.

Speaker 3

Yes. I think in terms of AST, I would definitely point And we have a number of legacy older plants that are quite full that tend to contribute at the high end of margin in the portfolio. The newer plants as they come online are somewhat dilutive on a percentage basis, but in aggregate with the total business, It doesn't really have a significant impact because there's been a steady diet of those plants coming on over the last few years. So we would expect With the exception of OpEx coming back, we would expect the margin rate in the ASP business pretty much. In terms of the life science business, the one caveat there is that there is some lumpiness to our capital shipments from quarter to quarter And the capital equipment business is generally at a lower margin than our service and our consumables business.

Speaker 3

So in a whole, as we continue to grow consumables at a nice rate, That will have an impact on the overall margin of the business. However, if we keep taking orders on the capital side of the business like we have, I'm not sure that that is going to hold up.

Speaker 5

Understood. Well, congrats again on a great quarter. Thank you.

Speaker 3

Thank you. Thanks, Chris.

Operator

Our next question will come from Mike Matson with Needham and Company. Please go ahead.

Speaker 4

Yes, thanks. So I want to

Speaker 6

ask one about the Renal Care Dale, we had estimated kind of $0.12 to $0.13 of dilution on an annualized basis, but I think you called out About $0.05 in the Q4, does that imply it's more like a $0.20 number on an annualized basis? And then can you just remind me what segment that falls or had fallen under previously, that revenue from that business?

Speaker 2

Yes, Mike, this is Mike. The majority of the revenue was falling under the healthcare side. So if you're going to adjust the model going forward, there was a small piece that was in the life Just business, but nothing really material. And then as far as I've seen a couple of different numbers, is it $0.03 is it 0 point 5 Some of this is IR math, if you will. But part of the issue is we are anticipating paying down debt In the Q4 with the proceeds, we did not get $190,000,000 a portion of that was held back in escrow.

Speaker 2

We did not pay down debt on onetwo. It took us a while to Clear the maturities that we have, we had some 30 day maturities that we waited to pay down debt. So there's some moving pieces here. Again, our best guess is it's around $0.05 So I wouldn't dramatically change for next year. If it's $0.04 or $0.04 2 who knows, but Again, more IR Matthews here than anything, more directionally, didn't give you an indication.

Speaker 1

And if I might, the business is about half capital as you're doing your

Speaker 6

modeling. Okay, got it. And then, just the really strong ASP Key growth, I think in the past you'd had some kind of COVID benefit in there from PPE and things like that. I mean is that Was that a factor at all this quarter? Or is this really just demand from your kind of normal medical device customers?

Speaker 3

Yes, it's demand from our normal medtech customers. The PPE has diminished back to pre COVID levels or less than right now.

Speaker 7

Okay. All right. And then

Speaker 6

just finally, just given the strong backlog, great to see that, I guess, increase in backlog. But I'm wondering to what degree is that a function of the really strong orders that you're getting clearly, But is there some role for the supply chain issues there and maybe limiting your ability? Like could you meet this Fulfill those orders more quickly or if these supply chain issues weren't happening right now?

Speaker 3

They would move a little quicker through the plants, but the So I think we said last quarter about $20,000,000 of capital shipments were deferred because of supply chain Either on our end or on the customer's end of things. And like I said, I don't think we're going to flush that through this quarter. It's going to take some time for those things to work themselves out. And the other thing too is a lot of these orders because a lot of it is long term capital investment from in particular the healthcare sector, They're not asking for them to be delivered on March 15 necessarily. So there's time to get these built and delivered for customer need when they actually

Operator

Our next question will come from Dave Turkaly with JMP Securities. Please go ahead.

Speaker 7

Hey, good morning. Can you hear me

Speaker 3

all right? Yes.

Speaker 7

Hi. Sorry, I'm in a bit of a spot. But Mike, I think you said leverage was at 2.6. And Obviously, the last few deals you did have been very accretive. So I just wanted to get a comment on maybe your appetite here and Where that leverage could go?

Speaker 7

Or can what's your capacity right now to do deals like that?

Speaker 2

Yes. So yes, as I mentioned, we have brought leverage Down below 2.6 times at the end of Q3, obviously, with the additional Payment of about $170,000,000 that we will put forward for the renal divestiture, obviously, leverage will continue to drop Lower than that by the end of the fiscal year. So right now, we are and have the ability to more than one times From a leverage standpoint, to do something from M and A standpoint, as we've been saying all along, The larger deals are few and far between. We will start getting back to more, I'll call it, tuck ins. But again, as everybody knows, We've been really more focused on the integration of both T Surgical and Cantel Medical.

Speaker 2

So the business development has been Slowed at this point in time, but we are getting back towards with leverage being below 2.5 at this point going forward. We are back to looking at opportunities to continue to grow the business, but more from a tuck in standpoint as what you've seen in the past.

Speaker 7

Thank you for that.

Operator

Our next question is a follow-up from Matthew Mishan With KeyBanc, please go ahead.

Speaker 4

Great. Apologies if I missed it. But I think previously you had reported FY 2022 numbers are around like $4,600,000,000 Is it fair just is that number still relatively Impact or are we closer to 4.45 or 455 now with the divestiture?

Speaker 2

Yes. I would say, Matt, I would still use higher math and round up to 4.6.

Speaker 4

Okay. And then on the Inflationary impact into the Q4, Are you sort of reporting this on a lag basis where you buy inventory at a higher cost a couple of months ago And then it starts coming through in January, February, March? Or are these the spot prices that you're seeing In the current market that could actually flow through into FY 2023?

Speaker 2

No. This will be the actual amount we anticipate based On the inventory turns and our various capitalization that we're talking about.

Speaker 4

Okay. But is it something in which is getting better Through at least on a spot basis, where you see going out a couple more months, the prices are starting to come down Or should we think about this big $20,000,000 level incrementally flowing through into next year?

Speaker 3

Matt, this is Dan. It's too early to say. We have definitely Spot prices for certain materials come down precipitously and we've seen other ones where we have vendors not even willing to close costs 3 months out So, our hope is that we see it come down over the next 3 to 6 months, but I think we're going to be living with some of these supply

Operator

This concludes our question and answer session. I would like to turn the conference back over to Julie Winter for any closing remarks.

Speaker 1

Thanks everybody for taking the time to join us this morning. We know it

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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