STERIS Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
February 8, 2024

There are 10 speakers on the call.

Operator

Good morning, everyone, and welcome to the STERIS PLC Third Quarter 2024 Conference Call. All participants will be in a listen only mode. Please also note today's event is being recorded. And at this time, I'd like to turn the floor over to Julie Winter, Investor Relations. Ma'am, please go ahead.

Speaker 1

Thank you, Jamie, and good morning, everyone. As usual, speaking on today's call will be Mike Tucic, our Senior Vice President and CFO and Dan Carrestio, 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 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 materially from those in the forward looking statements, including without limitation, those risk factors described in Stericycle 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. SAREZ's 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, constant currency organic revenue growth and free cash flow will be used.

Speaker 1

Additional information regarding these measures, including definitions, 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 intent of providing greater transparency to supplemental financial information by management and the Board of Directors in their financial analysis and operational decision making. With those questions, 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 10% driven by volume as well as 2 70 basis points of price. Gross margin for the quarter increased 50 basis points compared with the prior year to 43.6%. Price more than offset continued material and labor inflation in addition to the negative impact from currency.

Speaker 2

EBIT margin decreased 80 basis points to 23.1 percent of revenue compared with the Q3 last year. The anticipated increase in our year over year incentive compensation expense along with the mix shift in operating income from the AST segment Healthcare segment impacted EBIT margins. We anticipate that the mix shift in operating income from AST to Healthcare will continue in the Q4. The adjusted effective tax rate in the quarter was 22.6%. Net income in the quarter was $220,900,000 and adjusted earnings were $2.22 per diluted share.

Speaker 2

Capital expenditures for the 1st 9 months of fiscal 2024

Speaker 3

totaled $430,800,000

Speaker 2

Debt declined slightly to $3,300,000,000 in the 3rd quarter. Total debt to EBITDA at quarter end was approximately 2.2x gross leverage. Free cash flow for the 1st 9 months of fiscal 2024 was $457,000,000 compared with 200 $62,800,000 for the 1st 9 months of fiscal 2023. The fiscal 2024 increase was driven by higher earnings and declines in cash used for tax and compensation related payments as well as a decline in capital expenditures. With that,

Speaker 4

I will turn the call over to Dan for his remarks. Thanks, Mike, and good morning, everyone. Thank you for taking the time to join us hear more about our Q3 performance and our outlook for the rest of the fiscal year. As you heard from Mike, our Q3 continued the momentum we have experienced in our Health Care segment the past few quarters, and we also saw a nice improvement in Life Sciences. Overall, we are pleased with our performance.

Speaker 4

We continue to expect that our Healthcare segment will outperform our original expectations for the fiscal year, offsetting macro challenges impacting demand in our other segments. Looking at our segments, healthcare constant currency organic revenue grew 12% in the quarter. Supporting that performance, we had double digit growth across capital equipment, consumables and service again this quarter. This is driven primarily by procedure volume rebound in the U. S.

Speaker 4

As well as price and market share gains. As anticipated, backlog continues to normalize as we are shipping at a faster pace than new orders are coming in. Remember, our goal is to get back to historic production lead times and continue to meet customer demand. Speaking of demand, capital equipment orders in the Healthcare segment grew double digits in the quarter. Turning to AST, Constant currency organic revenue grew 4%, which was below our expectations.

Speaker 4

While we have continued to see more normalized volumes in the U. S. For medtech, Outside of the U. S. Remains softer than anticipated.

Speaker 4

In addition, bioprocessing volumes continue to contract. Until we have more clarity, we are taking a more conservative approach to our expectations for the Q4. Life Sciences grew 20% in the quarter on a constant currency organic basis. We had another strong quarter of capital which grew 57% against relatively easy comparisons. Remember, in fiscal 2023, revenue for both capital and consumables was shifted from the 3rd quarter to the 4th quarter due to some supply chain constraints.

Speaker 4

Consumables grew 8% and service revenue increased 12%. As you're hearing from others in the space, short term demand remains a bit murky and we continue to be optimistic about the long term growth opportunities for this segment. Our Dental segment 3rd quarter revenue declined 6% on a constant currency organic basis. Revenue was limited by reduced orders from a large due to a temporary disruption of their operations as a result of a cybersecurity incident they experienced during the quarter. Excluding that disruption, revenue would have been about flat in the quarter, which reflects the decline in patient volumes.

Speaker 4

The lower volume combined with the continued increases in material costs led to a decline in EBIT margin for the quarter. Turning to our outlook. Fiscal 2024 is shaping up to be another strong year for STERIS, albeit not exactly the way we had anticipated. In the last few years, if they've taught us anything, it's the value of our diversified portfolio. Time and time again, we have benefited as one of our segments outperforms compensate for challenges elsewhere.

Speaker 4

We are updating our outlook for the year to increase revenue to reflect the continued outperformance of our Healthcare segment. For the year, we now expect total revenue to grow 10% to 11% on a constant currency organic basis I'm sorry, in constant currency organic revenue growth of 7% to 8%, each up 100 basis points from our prior ranges. This assumes low single digit constant currency organic revenue growth in the 4th quarter caused by the record setting shipments in last year's Q4. EBIT margins for the fiscal year will decline slightly from fiscal 2023, primarily reflecting the shift in operating income mix from AST to Healthcare. Adjusted earnings per diluted share are now anticipated to be in the range of $8.60 to $8.70 for fiscal 2024.

Speaker 4

We recognize this outlook includes some conservatism, but believe it is warranted until we see the AST customer destocking abate have additional clarity on bioprocessing volumes. That concludes our prepared remarks for the call. Julie, would you please give the instructions and we can begin the Q and A.

Operator

Our first question today comes from Patrick Wood from Morgan Stanley. Please go ahead with your question.

Speaker 5

Perfect. Thank you very much. You guys still run one of the most efficient earnings calls of all time. It's much appreciated. I guess maybe starting with Healthcare, as you said, double digit growth across kind of all three of the main Verticals, I'd love to unpack that a little bit.

Speaker 5

I mean within the capital equipment side, I think last quarter was sort of 65%, Let's call it sort of replacement style projects and then roughly a third kind of expansionary. Is that the same kind of thing you're seeing now? And Should we expect that consumables line to remain pretty strong given the sheer amount of equipment you guys have been installing through this year if we look forward?

Speaker 4

Yes. I'll take the consumables. Mike, if you want to take the capital. Patrick, what I would say is, the consumables is a function of really 2 things. 1 is obviously patient demand in terms of procedures and obviously at least in the North American markets, demand is up across the board in terms of volumes flowing through hospitals.

Speaker 4

And then the other factor on that is just the sheer number of placements that we put out there over the last year in terms of maybe a little bit of share gain.

Speaker 2

And then on the capital side, obviously, you see that we continue to reduce our backlog levels, which is getting us more to our more normalized historic lead times and continuing to meet customer demand. But included in that, we did have double digit orders growth within Healthcare in the Q3. So, strong shipments in the quarter, but also good outlook with that double digit growth in orders for future.

Speaker 5

Amazing. And then maybe just quickly on AST. I guess within bioprocessing, the companies that themselves struggle to forecast their own demand kind of famously. So I wouldn't want to necessarily put too much stock there. But the commentary seems generally more optimistic on the forward look, I would say, from some of the big players.

Speaker 5

Is that something that you think resonates with you as you move through the next few quarters, like things on the bioprocessing side could get a little bit better? And then Equally within AST, the that how far through do you think we are in that inventory burn down given the procedure volumes have been so strong? I would have thought we don't have too long of that left. Is that fair?

Speaker 4

Yes. We would have thought that too, Patrick. So what I would say is We've seen the turn in the U. S. Market for the most part in medtech destocking.

Speaker 4

And that's a function of the efficiency of the healthcare systems comes over here and procedure volumes up being up significantly. They've been able our customers have been able to burn down that inventory a little quicker. In Europe, where there's still a lot of fits and starts in terms of medical procedures depending on the countries, We have not seen the burn down yet in inventory. And but inevitably this can't go on forever. I mean eventually those lines will cross.

Speaker 4

And then as it relates to the bioprocessing destocking, if we look over the long term, Historically and going forward with the exception of the blip that occurred for a couple of years during the pandemic, more than a blip to spike, It has been a very solid strong growth subset of products that we sterilize. And inevitably, I do believe that it will return to those levels of growth off of the reset number. The question is when do we get to that reset number? And as you've heard from many of our customers and their earnings and their outlook, they're taking a fairly conservative approach to the first half of the calendar year, but believe that many of them will see meaningful growth in the high single digits in the second half. If that comes true, that will translate to volumes for our AST business.

Speaker 5

Love it. Having been treated in both the UK and the U. S, I'm glad I live here from a healthcare perspective. Thanks for taking the questions.

Speaker 6

You're welcome.

Operator

Our next question comes from Brett Fishman from KeyBanc. Please go ahead with your question.

Speaker 6

Hey guys, thanks so much for taking the questions. Just wanted to start off with a question on some of the margin dynamics. Understand the unfavorable revenue mix shift was the primary moving piece this quarter. But just wondering if you could give a bit more color on some of the previous key moving pieces around margins, like productivity and cost inflation and how those have progressed into the back half?

Speaker 2

Yes, Brett. The one thing we are missing that I did talk about, we've been talking about all year is the incentive comp hole that we had to refill, which was about a $40,000,000 headwind. The bulk of that, about $22,000,000 of that was are impacted in the Q3. So that is a huge hole that we had to fill in Q3. On the more favorable positive side, we have seen price for the first time actually offset labor inflation, and we did see Flat productivity.

Speaker 2

We had seen negative productivity as we were moving as we talked about moving products, especially the capital equipment and touching those products several times in order to get them out the door in our manufacturing process. So we've actually seen an improvement significant improvement in productivity. I think productivity was right around negative 150 basis points, 200 basis points last quarter and it's flat this quarter. So very good movement there from a manufacturing standpoint. That just shows that from a supply chain standpoint, we are seeing our supply chain continuing to ease and doing a nice job of

Speaker 6

around AST. Just wondering if you could provide a bit of an update around your progress in adding more X-ray sterilization capacity as an alternative modality your network. If I'm not mistaken, you have a couple locations already up and running. And I think there are some additional ones that might come online in the next few years. So just any additional details would be great.

Speaker 6

And thank you for taking the questions.

Speaker 4

Yes, sure. This is Dan. The 2 of the U. S. Sites will come on line this calendar year.

Speaker 4

That's in Chicago, Libertyville, Illinois area. That is in testing phase now and should be running product in the next few months. And then the second one that will come online will be California, Ontario, California and that will be in the fall.

Speaker 1

And then outside of the U. S, we have several projects underway.

Speaker 4

We do, yes. I mean, we have The Asian site coming online as well now. And then I don't I can't remember off the top of my head the pacing of the couple of the insights, but there's a few of those that will come online in the next 18 months as well.

Operator

Our next question comes from Jacob Johnson from Stephens. Please go ahead with your question.

Speaker 7

Hey, thanks. Good morning. Maybe just one on margins to start. Just on AST margins, I think they declined sequentially on a similar revenue base, was that mix? Was that incentive comp?

Speaker 7

Just anything you'd call out there? And any thoughts on how we should think about that into the 4th quarter?

Speaker 4

A general comment, Mike, I'll let you add to it. We typically see some decline in Q3 and that's because of the holidays, right. So we're not there's not as many days of billing that goes on because customers have shutdowns often over the Thanksgiving week over the Christmas holiday week between Christmas and New Year. So unless we're sitting on backlog in the factories, we tend to lose some time there. So as a result, it has an impact on margin, but That's a normal sequential trend that we see from Q2 to Q3.

Speaker 4

Unless there has been a few times in history where that has not we've bucked that trend because bioprocessing volumes were through the roof or something we had to run off backlog. But generally speaking, that's a normal thing you would expect. It's probably a bit exaggerated by the fact that we saw much lower volume than anticipated in the European plants.

Speaker 2

And we did have some cobalt loadings where we actually took our plants off of line for the quarter. I think we had 6 cobalt loading. So that also hurt from a productivity standpoint, which negatively impacted margins.

Operator

Got it. Thanks for that,

Speaker 7

Dan and Mike. And then just maybe as a follow-up on the Life Sciences segment. Obviously, strong performance. Dan, it seems like from your comments, Some of that was just easy comps, but you also kind of struck some maybe positive turn around the longer term outlook there. I'm just curious kind of what seeing in terms of demand there as it relates to aseptic manufacturing clients, because that's been in focus somewhat this week?

Speaker 4

Yes. It's funny in the life science business when we ship in revenue product that's really the ancient history for us because oftentimes those are orders booked a year in advance. And as you indicated, we had really fairly easy comparisons to our Q3 last year in terms of shipments. And then if you recall, we had a really nice Q4. So I think it's those two things.

Speaker 4

We're not ready to raise the flag yet in terms of long term what's going on in aseptic manufacturing demand. We know that the long term is a great outlook, but short term, there There's still some destocking that's going on and there's still some pressure on big pharma right now. But in generally long term, Clearly, aseptic drugs, injectable drugs, biologics, cell and gene therapy, all those type of things, all those markets we serve with sterilization type products and services are going to be in high demand.

Operator

Got it. Thanks for taking the questions. Our next question comes from Michael Pollard from Wolfe Research. Please go ahead with your question.

Speaker 8

Good morning. Thank you for taking the question. Might be too early, but I'd be curious for puts and takes as we move into fiscal 2025. Penciling out the model here last night, see a path to 6% organic revenue growth, maybe A touch better pending AST and the historical STERIS posture on EBIT margin, 30, 50 bps of expansion and That feels fair for now. I just as you get ready to plan for next year, Do you feel like the environment allows for I mean, knowing there's portfolio puts and takes, but at an overall level, do you feel like it sets you up to shoot for that normal STERIS algorithm?

Speaker 8

Or do you see it differently at this early stage?

Speaker 2

Mike, your opening comment, it's a bit too early for us to comment at this point in time. You answered your own question there a little bit. Obviously, we're in the middle of our planning process. We will, as we typically do, provide FY 2025 guidance in May on our full year Q4 call. So that's where we stand right now.

Speaker 8

Had to try. AST, I guess the AST question is 2 parter. Obviously, we see procedures are back. I mean, MedTech Probably behaving well. You're saying the U.

Speaker 8

S. Is good. OUS still a little iffy. OUS, is there any kind of COVID era product category that's still contributing to this? I'm thinking of PPE Or is it just the European kind of procedure recovery is more sober and that's it?

Speaker 4

That's it. It's specific to Europe too we've seen pretty decent recovery in our Asia Pacific plants. So this is a predominantly European demand issue that's just Well, not necessarily demand, it's ability to deliver healthcare issue that's taking longer to burn down inventories.

Speaker 8

The second piece, I'd just like large interventional multinational med techs, I'm thinking hip, sneeze, dents, Pacers, stuff like this. Are these customers telling you that they maybe have a little too much and need to be slower on ordering or you just You're not hearing that and you're just No, that's

Speaker 4

the communication we get we've received from customers. We've had many say that they're burning down inventory as much as 40 from where their current levels were. That's a function of what happened during the pandemic and post pandemic and inventory in the supply chains in manufacturing and in raw and everything got fairly bloated because of concerns around the surety supply. And that compounded with a reduction in procedure rates over in Europe is taking longer to burn it down.

Speaker 8

Appreciate the comments. Yes. And Mike, we're

Speaker 2

all going to get you to try in.

Operator

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

Speaker 8

Hey, good morning, everyone. I'll start first Following maybe on some of the prior questions on segment margins, I was going to take a stab at fiscal 2025, but Mike already tried that. So I'll go a different route. It sounds on margin side like you're not too worried about the AST profit level we saw. 3rd quarter is the seasonal low point, but is there anything structural keeping us from getting back to the upper 40% margin levels we saw in fiscal 2022 and the 1st part of 2023?

Speaker 8

Or are those just tough to match given the volume list you were seeing at the time? And then similar question, but on the other side in health care, how sustainable do you see segment margins in that segment? I think it hit a new high this quarter. Is the strength there simply a function of the and equipment volumes you're seeing? Or is there any kind of uplift that's coming from the assets you acquired from BD?

Speaker 2

On the AST side, it's all volume, Jason. This is a very high fixed cost base segment. The more volume we put through, the better opportunity we have to drive increased, EBIT margin. So there it's all volume. Dan, you want to Address Healthcare?

Speaker 2

Yes.

Speaker 4

No, I don't see any fundamental changes really in the Healthcare. That once again as long as our delivery rates stay up high, it should be fairly consistent plus or minus a dip per 2 one way or another from quarter to quarter.

Operator

And BD is slightly incremental. BD is slightly incremental.

Speaker 8

Okay. I don't want to lead either of you, but it sounds like, Mike, you're saying nothing structural from getting from getting back to the upper 40s in AST and Dan you're saying nothing structural that would keep you from maintaining the margin level you're at right now in healthcare?

Speaker 2

Yes, correct.

Speaker 8

Okay. All right, great. And then over on Dental, I'm sure I probably have asked this A few different times now in consecutive calls. You've been reviewing internally the future plans for the asset. This was a weak quarter, Part of that out of your control, you had Henry Schein cybersecurity attack.

Speaker 8

But I guess maybe two questions on those items. Can you say first whether near term trends have normalized, following that cybersecurity attack and the kind of the resolution we've seen with that business and that issue? And then can you talk about the conversations you're having regarding the future for this segment? Do you have a timeline on when you'll announce a formal decision here?

Speaker 4

Yes. I guess on the first, we have seen things normalize in terms of regular order pace and whatnot. The challenge is a lot of that revenue kind of evaporated and get shifted into Q4, at least we anticipate to some degree or it found other venues to get to the customer, which we don't really have the ability to track fully understand. So we'll see what the outcome is of that more definitively this quarter. On the other question, We continue to look at the portfolio in general, but no decisions have been made at this point.

Speaker 4

And as soon as we have something to update, you and everyone else with on this matter, we will do so.

Speaker 8

All right. Thanks so much guys.

Operator

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

Speaker 3

Yes, thanks. Just want to ask one Use of cash. So, I think you've done a fair bit of M and A. I don't recall any recent share repurchases, but maybe I'm forgetting one. But can you maybe just give us an update on your kind of priorities and whether or not you'd be willing to Come in and do some share repurchases?

Speaker 2

Yes. Mike, our capital allocation methodology or process has not really changed over the last decade plus. We did, if you remember last year in Q4, we did were opportunistic in share repurchase. We bought about $225 ish million of shares. We have not purchased any in FY 2024 to date.

Speaker 2

We've actually been focusing more on paying down debt since rates are higher. We feel there's value in paying down debt. So all of our excess cash has been going towards debt repayment, which has driven our leverage ratio, even with the BD acquisition, we're at 2.2 times gross leverage. So that's been our focus.

Speaker 3

Okay, got it. And then, I believe you've been able to get a little more pricing in recent periods. How sustainable do you think that that rate of price increases as we see inflation kind of Slowing down here a bit.

Speaker 4

Yes. I think that to some extent our ability to justify putting through price increases with customers has to be some basis of cost. And as cost can normalize in certain areas, Yes, there will be a market trend towards less price grab, I guess, is what I would say.

Speaker 3

Okay. And then finally, Just want to ask one on the outlook for tax rate with Pillar 2. I mean, your rate is kind of well above that 15% level, but do you expect any sort of impact there To your tax rate?

Speaker 2

Mike, nothing material from Pillar 2, if and when it does get implemented.

Speaker 3

Okay, great. Thank you.

Speaker 2

You're welcome.

Operator

Our next question comes from Dave Turkaly from JMP Citizens.

Speaker 9

Sorry, I've been bouncing around a bit. You may have talked about this, but I wanted to just ask quickly, Any update on that radiation sterilization master file pilot program like in terms of participation or anything we should assume, Anything you've learned or anything you think we could look at in terms of how that might impact things moving forward?

Speaker 4

Yes. Dave, this is Dan. It's been very positively received by the customers and also by the regulators with the agency FDA. And we're excited about the program because it does sort of create a lower regulatory barrier switching barrier for our customers to have more supply flexibility when changing different modes of sterilization. So this is something that we felt was important to offer up to the industry and work with the FDA to get that approved, so that there was much more flexibility in a time couple of years ago when everybody was exposed and challenged.

Speaker 4

So no material impact in the short term here do we expect. But I think that longer term, it's a great program for us and bodes well for our customers.

Speaker 9

And then just quickly as a follow-up, when you look at like EO, if they're transferring from that, like is the margin profile much different Via the different modes in AST, that they might switch to?

Speaker 4

Not really, no.

Speaker 9

For you? Okay.

Speaker 8

Thank you. Yes, sure.

Operator

And our next question is a follow-up from Michael Pollard from Wolfe Research. Please go ahead with your follow-up.

Speaker 8

Thank you. Healthcare Capital, as I kind of run review the numbers or the fresh set of numbers and I know this it's not how you manage it. You have customers waiting for product and you want to ship as quickly as possible. But I kind of see the makings of a soft landing here for Healthcare Capital Revenue in 2025. There had been a fear that it might likely be down as you kind of improve lead times and conversion rates.

Speaker 8

But again, I kind of see this kind of Goldilocks scenario where growth decels for sure, but assuming orders continue at these current levels, you're still growing healthcare capital revenue in fiscal 2025. I know you don't have guidance out there, but I'm curious what you think of my theory.

Speaker 4

I love your theory and I hope it plays out that way.

Speaker 8

Okay. And one other follow-up. Cobalt 60, I heard the comments on maybe a little bit of downtime from loading and we know that Nordeon was exceptionally calendar 4Q weighted in terms of deliveries in calendar 2023. Is there some element that now that you're back to like full strength at those plants, The gamma network speeds up in the short run. I'm just curious how that actually works.

Speaker 4

It does, but we have to have the volume is the issue. So we needed to take the cobalt because we've gotten to a deficit position in many of those plants because it's been for some of them over a year since they last loaded. But It doesn't it should not have a material effect unless we get more volume than we anticipate. And if we do, we'll be able to run it because we'll have more capacity.

Speaker 8

Thanks for

Speaker 9

taking the follow ups.

Speaker 4

Sure. Thanks.

Operator

And ladies and gentlemen, with that, we'll be ending today's question and answer session. I'd like to turn the floor back over to management for any closing remarks.

Speaker 1

Thanks, Jamie, and thanks everybody for taking the time to join us this morning. We look forward to up with many of you in the coming weeks.

Operator

And ladies and gentlemen, with that, we'll conclude today's conference call and presentation. We thank you for joining.

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