STERIS Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
November 8, 2023

There are 8 speakers on the call.

Operator

Good morning, everyone, and welcome to the STERIS Plc Fiscal Second Quarter 2024 Conference Call. All participants will be in a listen only mode. After today's presentation, there will be an opportunity to ask Please also note today's event is being recorded.

Speaker 1

At this time, I'd like to

Operator

turn the floor over to Julie Winter, Vice President of Investor Relations. Ma'am, please go ahead.

Speaker 2

Thank you, Jamie, and good morning, everyone. As usual, speaking on today's call will be Mike Tokich, our Senior Vice President and CFO And Dan Crestio, our President and CEO. 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 Some of the statements made during this review are or may be considered forward looking statements.

Speaker 2

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 developments. 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, adjusted operating income, is available in our release as well as reconciliations between GAAP and non GAAP financial measures. Non GAAP financial measures are presented during this call with the and operational decision making.

Speaker 2

With those questions, I will hand the call over to Mike.

Speaker 3

Thank you, Julie, and good morning, everyone. Is once again my pleasure to be with you this morning to review the highlights of our 2nd quarter performance. For the quarter, constant currency organic revenue increased 8% driven by volume as well as 3 30 basis points of price. Gross margin for the quarter decreased 50 basis points compared with prior year to 44.3 percent. Favorable price was more than offset by lower productivity and continued material and labor inflation.

Speaker 3

EBIT margin decreased 130 basis points to 22.5 percent of revenue Compared with the Q2 last year, which reflects the decline in gross margin as well as the anticipated increase in year over year incentive compensation expense. The adjusted effective tax rate in the quarter was 23.7 percent. Net income in the quarter was 202 point $2,000,000 and adjusted earnings were $2.03 per diluted share. Capital expenditures for the first half of fiscal twenty twenty totaled $149,900,000 while depreciation and amortization totaled 290,200,000 We are adjusting our capital spending outlook for fiscal 2024, down from $375,000,000 to 310,000,000 This change reflects the timing of projects for AST business. This change will allow us to offset Higher than planned inventory levels, keeping free cash flow outlook for fiscal 2024 at approximately $685,000,000 Debt increased to $3,400,000,000 in the 2nd quarter, reflecting borrowings to fund the acquisition of the BD assets.

Speaker 3

Total debt to EBITDA at quarter end was approximately 2.3x gross leverage. Free cash flow for the first half fiscal 2024 was $284,700,000 as we benefited from lower capital spending and the decline in cash Use for tax and compensation related payments. Inventory remains elevated as we continue to focus on reducing lead times and meeting customer demand. With that, I'll turn the call over to Dan for his remarks.

Speaker 4

Thanks, Mike, and good morning, everyone. Thank you for making the time to join us to hear more about our Q2 performance And our outlook for the rest of the fiscal year. As you heard from Mike, our Q2 continued the momentum we have experienced in our Healthcare segment for the past few quarters. Overall, we are very pleased with our performance in the Healthcare segment and is anticipated to outperform our original expectations for the fiscal year, offsetting the macro challenges impacting demand in our other segments. Looking at our segments, healthcare constant currency organic revenue Grew 14% in the quarter.

Speaker 4

We experienced double digit growth across capital equipment, consumables and service again this quarter. This is driven primarily by procedure volume rebound in the U. S. As well as price and market share gains. As anticipated, our backlog has reduced as we are able to ship at a faster pace than new orders are coming in as we get back to normal lead times for our customers.

Speaker 4

During the first half, we saw strength in replacement orders, representing 65% of our total orders in healthcare. We are increasingly confident in our expectations of a strong year for our Healthcare segment. Growth will, however, decelerate in the second half as We faced very challenging comparisons in the Q4. Turning to AST, constant currency organic revenue declined 1%. While our services business grew 5%, our capital equipment business declined due to the timing of large shipments.

Speaker 4

In addition, our performance in the quarter continued to be impacted by 2 short term situations. Inventory destocking in the medtech space We saw good growth in the U. S. During the quarter, reflecting the improving procedure environment and the burn down of customer inventory. We continue to see weakness, however, in the European markets, where procedure recovery is taking a bit longer to take hold.

Speaker 4

From a bioprocessing perspective, as we have said, FY 2024 represents a bit of a reset and we do not anticipate returning to year over year growth 2023 when we first witnessed declines in bioprocessing. Based on these factors, our outlook continues to reflect very strong growth in the second half The fiscal year for our AST segment as compared to the first half. Life Sciences revenue grew 5% in the quarter On a constant currency organic basis, as the delayed capital shipments from the Q1 were recognized contributing to 18% growth in capital equipment. Consumables grew 4% and service was flat. As you are hearing from many others in the space, the short term demand remains a bit murky.

Speaker 4

We continue, however, to be very optimistic about the long term trends driving demand for aseptic manufacturing and biopharma. Our dental segment 2nd quarter revenue declined 6% on a constant currency organic basis as revenue was limited by customer destocking of inventory, in particular for infection control products. Despite these challenges, we are impressed with the ability of the business to sequentially improve margins, delivering EBIT margins above total company in the quarter. All in, we are pleased with the first half of the fiscal year. U.

Speaker 4

S. Procedure trends continue to shift in a positive direction, supply chain challenges have largely abated and our ability to execute and ship capital products to our Customer delivery times has greatly improved. That said, there are still pockets of uncertainty, which remain outside of our Healthcare segment. We are maintaining our expectations of 6% to 7% constant currency organic revenue growth for fiscal 2024 as we expect a strong third quarter followed by a very tough 4th quarter comparisons, which will limit our total growth in the second half. In addition, from an earnings perspective, we now have an additional headwind from currency of about $0.05 which we are absorbing in our current outlook of $8.60 to $8.80 That concludes our prepared remarks for the call.

Speaker 4

Julie, would you please give the instructions and we can start the Q and A.

Speaker 2

Thank you, Mike And Dan for your comments. Jamie, can you please give the instructions for Q and A and we can get started.

Operator

Ladies and gentlemen, we'll now begin the question and answer session. Our first question today comes from Johnson Jacob from Stephens. Please go ahead with your question.

Speaker 5

Hey, good morning. Thanks for taking the questions. Maybe Dan or Mike, following up on kind of the last comments and the 2024 outlook. It seems like Some of the year is playing out as expected, and I appreciate the comps, but it also seems like healthcare Going better than expected. Can you just talk about the other three segments and where things have changed the most?

Speaker 5

I think reading the tea leaves, Dan, maybe it seems like life sciences It's the biggest delta since the beginning of the year, but just curious kind of how those other three segments are playing out this year versus original expectations?

Speaker 4

I mean, I think we still expect to deliver a good year in life sciences. It's just there's still some continued destocking going on in the space. And you see this across everybody that's Reported that sells either tools or disposables into the biopharma and pharma industries in general. It's been announced in the last month or so that Pfizer is $3,500,000,000 cut and some other pharma companies are sort of following suit. So generally speaking, when we see that start to happen, there'll be a short term pullback in the industry.

Speaker 4

But the long term outlook for biopharma and aseptic manufacturing, which is really our sweet space It's really positive and we have a great portfolio and expect to do well. In terms of the AST business, As I mentioned, we've seen a positive trend in the U. S. I think the procedures have crossed over with sort of the excess inventory that was out there in the past And we're seeing very positive growth from our medtech customers. In terms of Europe, it's taken a bit longer for that to happen.

Speaker 4

There's been a lot of strikes there's been a lot of labor shortages in Europe, and just have not mobilized healthcare delivery in many places the way the U. S. Has to date. Eventually that will abate and even if it doesn't eventually they're going to burn down the inventories in excess they have sitting around. And I would have expected that around the time that we saw it in the U.

Speaker 4

S. I think as I mentioned in previous calls, we expect it sometime in the fall Time period. That's still the case that could burn into the winter, I guess. But generally speaking, it's a matter of Weeks or a few months, not quarters at this point. And then I think we've covered bioprocessing at length.

Speaker 4

Last year Q2 was our high point, and then we started seeing it slowing in Q3 and ultimately sort of bottomed out by Q1 1 of our fiscal year, give or take. So the comps get easier for us in the second half for that in terms of our performance, especially as we get into Q4 and then Next

Speaker 3

fiscal year.

Speaker 5

Got it. Thanks for all that. Just I guess my follow-up, Just on backlog, both Healthcare and Life Sciences down sequentially. Is it fair to say Healthcare is more about kind of execution and you catching up on lead times and maybe life sciences a little bit at the macro or anything else you'd share on that? Yes.

Speaker 4

No, I would say both are just getting products out the door. We had a lot of stuff that was supposed to move out in the prior quarter in life sciences particular that slid till the end of the quarter and didn't get recognized till this quarter. So that's just purely a timing issue and the orders remain pretty strong. And we've just been able to get a More stuff out of our factories, as we bring our lead times down pretty significantly. So we just had a great delivery quarter from capital in general cross post businesses.

Speaker 5

Thanks for taking the questions.

Operator

Yes, sure thing. Our next question comes from Dave Turkaly from JMP

Speaker 6

I just wanted to ask one follow-up on the AST side. It seems like we have some companies that are saying demand is super high. They're actually like experiencing bottlenecks to get devices sterilized. And you mentioned the timing Projects for ASG. And I'm just curious, is there a shift going on between some of the modalities there?

Speaker 6

What exactly The MedTech customer inventory that you're highlighting, are you seeing?

Speaker 4

Well, like I said, we have Seeing demand come back really strong in the U. S. Market in the past quarter, back to what I would consider sort of normalized growth rates versus what we saw for the past 2 or 3 quarters. It's taking a bit longer for that recovery to happen outside of the Yes. The plants are busy in North America and they're not as busy.

Speaker 4

I would get I guess is what I would say outside of the U. S. We expect that to change in the next quarter or so.

Speaker 2

And Dave, the shortages I think have been more tied to EO Sterilization?

Speaker 4

Yes, Burton.

Speaker 2

Where our softness has been on the radiation side. Yes.

Speaker 6

No, that makes sense. And then maybe just a follow-up for Julie or the team that master filed the pilot program. I'm just curious as to what you think that means for you. Obviously, it's I think you said it's STERIS' first, but I don't know how to sort of Analyze that or what you think that will mean for you moving forward?

Speaker 4

Yes. So Dave, so what it does is it really gives our customers the ability to Significantly improve and build much more resilient supply chains. Specifically, it allows them to switch Between different modes of sterilization, whether that's EO to X-ray or gamma to X-ray or even e beam to gamma or even to switch within our network of either our facilities or technologies Without having to do a massive refile from a regulatory perspective. So products that are under 510 Would not have to do a refile effectively. They would enter under our master file program.

Speaker 4

And then when they had their next normal sort of course of audits from the agency, They would check their records just to make sure everything was in place. But it lowers a significant regulatory hurdle, I would say, That allows customers to build in much more resiliency and also switch between technologies.

Speaker 6

Great. Thank you.

Speaker 4

Sure. Thanks.

Operator

Our next question comes from Michael Pollard from Wolfe Research. Please go ahead with your question.

Speaker 1

Hey, good morning. For the back half, it obviously the segment has the mev ex in it, and you break it out, so that's helpful. Not a lot of mevEx in the front half. Can you help level set how much mevEx you expect in the back half?

Speaker 3

In the second half, it will be less than $15,000,000 of total revenue 1st, the first half, which was about $3,000,000 Again, not material, but unfortunately year over year the percentages Are large, but the dollars are not.

Speaker 1

Yes. Understood. No, it's helpful. And then on the AST services phasing, look, I hear all The destock comments and it sounds like light at end of tunnel, especially in U. S.

Speaker 1

Devices and bioprocess Worst of it annualized in now. I'm looking at AST Services in the front half, up 5% year on year. That's kind of a good either sequential growth rate or year on year growth rate to plan for in the back half?

Speaker 3

Yes. In the second half, like we expect double digit low double digit growth rates getting back to more normalized.

Speaker 1

In the AST Services line?

Speaker 3

The AST Services line, exactly.

Speaker 1

Okay. Helpful. Appreciate that. Then the follow-up topic,

Speaker 6

equipment, healthcare,

Speaker 1

It's not a metric you report, but we can do our own math, and calculate a book to bill, if you will, For you for Healthcare Equipment, it was like 1.0 last quarter, it was sub 0.9 this quarter. But my question is on like The fresh order environment and I want to set it up this way like you have a big backlog, you have been working real hard to convert the backlog And we're seeing conversion rates tick up and that's pretty clear. I wonder about Like your willingness to refill the backlog as fast? Like is there an element where you just do you need to bid for New business as much in the moment right now as you otherwise would because of the backlog and that's a dynamic. So I'm curious there.

Speaker 1

And then just probably on hospital, capital spending, if you will, as we move into calendar 2024, like Similar seeing stresses and strains, no impact and any thoughts on this would be great. Thanks.

Speaker 4

Yes, just a That's a lot. Just a couple of comments and I would say our orders remain strong and I mean there's so much activity out in the in terms of our portfolio right now. And yes, one of the positive signs I saw was the significant increase in the replacement business in the last quarter or so versus the prior few periods. And that tells me that A, our customers have confidence we can and our field also has confidence we can deliver in a relatively short period of time with normal lead times. And B, they're willing to spend money on a lot of pent up maintenance CapEx that hospital systems have.

Speaker 4

I've talked about this before, and that is that although the healthcare providers are not necessarily killing it financially right now, They definitely are on a path to profitability and many of them are in a good cash flow situation, whereas there was a lot more concern a year ago. And the reality of it is as well as that our capital equipment is not they're not luxury products. These are capacity enablers. You can't do procedures without lights Tables, you can't do procedures without adequate capacity in the sterile processing department. And that's really what we do.

Speaker 4

It's not all that sexy, but, it's a requirement.

Speaker 1

Thank you.

Operator

And our next question comes from Mike Matson from Needham and Company. Please go ahead with your question.

Speaker 7

Yes, thanks. I guess I'll start with the dental business. It was down again. It looks like you're Starting to lap some of the declines that you've been seeing. So is that I guess just what's The outlook there, is it just really boiled down to kind of the economic headwinds or something else maybe?

Speaker 4

Yes. I mean short term, we expect it to be about flat this fiscal year. And we would attribute that entirely to the economic Downturn in the ability of people to spend cash right now on elective type dental type procedures and it's just generally impacting the entire and others have spoken up that on that topic prior to us, I'm sure in the last couple of weeks. Long term, we think it's a solid mid single digit grower. But some of these challenges facing discretionary spending, in particular, the U.

Speaker 4

S. Economy got to get sorted out in order for it to get back to those type numbers.

Speaker 7

Yes. Okay. And then, it does look like you're obviously working down the backlog in The healthcare business. But, and once I wanted to ask about just hospital staffing with regard to the getting the equipment installed. I know that that's been an issue in the past, at least with some companies.

Speaker 7

Have you seen that improving? Is that still Constraint on the ability to book the revenue there?

Speaker 4

No, we've seen that. I mean, there's more coordination today than there to be maybe in terms of getting stuff received at the docks and getting shipments married up so we can do install. But keep in mind, we've got well over 1,000 techs the U. S. That do this work for us, that are full time STERIS employees that are ready to go to help shepherd the process to get our stuff into the doors and also get it installed properly.

Speaker 7

Okay, got it. And then, I know you may have addressed this in the prepared remarks, but I got on call late. So I just wanted to ask about Gross margin, it did look like it was down a little bit sequentially. And You had a nice improvement, I guess, last quarter sequentially from the Q4, but just any kind of commentary there would be helpful.

Speaker 3

Yes, Mike, we had mentioned in the prepared remarks that even though margin gross margin was down 50 basis points, we did have favorable price, but unfortunately that was More than offset by lower productivity and continued material and labor inflation. So the productivity As we are moving stuff through the facility, we are not as efficient as we typically would be. So that That negative productivity is hurting us in the short run.

Speaker 7

Yes, got it.

Speaker 2

AST volumes declined sequentially don't help margin either.

Speaker 7

Yes. Okay. Thank you.

Operator

Our next question comes from Jason Bednar from Piper Sandler. Please go ahead with your question.

Speaker 1

Hey, good morning. Thanks for taking my questions here. I want to start on, I think, the topic of the day here at AST, but maybe first on the CapEx side with AST, just the decision to postpone some of those projects That's influencing the CapEx outlook for the year. I appreciate you wanting to protect free cash flow, but is there a risk at all here that you're foregoing future growth in AST, just not adding capacity. And should we be thinking about this CapEx spend Shifting out of fiscal 2024 into 2025 and just next year being an above normal year of CapEx spend?

Speaker 4

Yes. Jason, this is Dan. Thanks. Thank you for the question. Just to be very clear, we're not delaying these shipments.

Speaker 4

They were delayed just by natural building and Just current environment of getting things installed and everything else and permitting processes and everything else. So it's we have not Intentionally slowed those in any ways. They've just naturally slowed. And yes, the answer is we would expect those now to be would Bleed over into next fiscal year from a CapEx perspective. We haven't pulled any projects specifically.

Speaker 4

Yes.

Speaker 1

Okay, Dan. You're talking about the CapEx spend, not the equipment that you're recognizing as revenue, just to be clear?

Speaker 4

Correct. Yes, I'm talking about CapEx spend.

Speaker 1

Okay. So it was like $65,000,000 that shift that of spend that's shifting out of this year into next year?

Speaker 3

Yes. The bulk of that is AST. It's not 100 percent AST, but the bulk of that $65,000,000 is directly related to the AST segment.

Speaker 1

Got it. Okay. All right. Thank you. And then we've had some questions here on backlog.

Speaker 1

It sits down $100,000,000 from peak levels. I know we were running well above normal for a long period of time. What do you see as the baseline? Where do you think backlog settles a normal environment, how much more backlog work down do you think we need to see before we're kind of at that again that normal level?

Speaker 4

We think normal is somewhere around $350,000,000 but we're happy to keep it higher if we keep pulling in orders. It was artificially high in the past of our ability to manufacture and deliver. And as we've sort of solved those issues from a supply chain perspective, It's now really coming down at an accelerated pace.

Speaker 3

Although I would say that our lead times continue to be longer than we would like To be, yes.

Speaker 1

Okay. All right. Thanks. And then last question for me. I don't think I heard it, But if I did, I apologize.

Speaker 1

Are you able to bifurcate what you're seeing with your USAST And contrast that against what you're seeing in Europe. How much of a growth rate delta are you seeing across those two markets? It seems like the opportunity for improvement here is more dependent on the European market improving. So just wondering what kind of visibility you have on Procedures in that geography recovering and if you're seeing anything or hearing anything from your partners that would be an encouraging leading indicator?

Speaker 4

We do look at it. We have a lot of data points obviously being in the hospitals and also dealing with directly with all of our customers Their insights on what's going on in the market and there's a lot of public information from NHS and the other public health commissions in Europe. What I would say is it's got to get better. And even if the procedure rates don't improve, at some point the inventory burn down crosses And we get back to normal stocking from our customer perspective. And everybody got really bloated on inventory over the last couple of years And everybody now is trying to bring it down.

Speaker 4

And we've heard some customers say as much as 40% or 50%. And that takes Like I said, we've crossed that over that line in the U. S. And we believe that we'll get to that point in coming weeks or months, definitely not quarters, I would say, relative to the European destocking as it relates to medtech. And the other driver we talked about is as we get into the back half of the year, the comps on bioprocessing, the single use disposables Become a little easier against us.

Speaker 4

That's been a real headwind for the 1st 2 quarters of the year.

Speaker 1

Okay. All right. Thank you.

Operator

And ladies and gentlemen, at this point, I'm showing no additional questions. I'd like to turn the floor back over to the management team for any closing remarks.

Speaker 2

Thank you everybody for taking the time to join us. I know you have a busy week.

Operator

Ladies and gentlemen, with that, we'll conclude today's conference call and presentation. Thank you for joining. You may now disconnect your

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