STERIS Q1 2024 Earnings Call Transcript

Quartr
Provided by Quartr
August 2, 2023

There are 10 speakers on the call.

Operator

Good day, and welcome to the STIRIS Plc First Quarter 20 24 Earnings Conference Call. All participants will be in a listen only mode. Please note this event is being recorded. I would now like to turn the conference over to Ms. Julie Winter, Vice President of Investor Relations.

Operator

Please go ahead.

Speaker 1

Thank you, Chuck, and good morning, everyone. As usual, speaking on our call today will be Mike Tokich, our Senior Vice President and CFO and Dan Crestio, our President and CEO. 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 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, 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 press release as well as reconciliations between GAAP and non GAAP financial measures. Non GAAP and 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 Q1 performance. For the quarter, constant currency organic revenue increased 11%, driven by volume as well as 2 90 basis points of price. Gross margin for the quarter decreased 30 basis points compared with the prior year to 44.8%. Favorable price was more than offset by continued And labor inflation as well as lower productivity.

Speaker 2

EBIT margin decreased 50 basis points to 22.4 percent of revenue compared with the Q1 last year, which reflects the decline in gross margin as well as the anticipated increase in year over year incentive compensation, which is recorded in corporate and other. The adjusted effective tax rate in the quarter was 22.6%. Net income in the quarter was $198,200,000 and adjusted earnings were $2 per diluted share. Capital expenditures for the Q1 Totaled $66,600,000 while depreciation and amortization totaled 137,900,000 Debt declined slightly in the Q1 and totaled just over $2,900,000,000 Total debt to EBITDA was approximately 2.1 times gross leverage. Free cash flow for the Q1 of 2024 was $214,500,000 as we were able to collect on our strong 4th quarter revenue.

Speaker 2

Inventory remains elevated as we continue to focus on reducing lead times and meeting customer demand. With that, I will turn the call over to Dan for his remarks.

Speaker 3

Thanks, Mike, and good morning, everyone. Thank you for making time to join us to hear more about our Q1 performance and our outlook for the rest of the fiscal year. As you heard from Mike, we had a strong start to our new fiscal year, exceeding our plans and the Street's expectations. Looking at our segments, Healthcare constant currency organic revenue grew 18% in the quarter. We experienced double digit growth across capital equipment, consumables and service.

Speaker 3

This is driven primarily by Procedure volumes in the U. S. Continuing to rebound as well as price and market share gains. The improving supply chain environment coupled with our ability to reduce lead times led to a very strong quarter of capital equipment shipments. Hospital capital spending remains robust as evidenced by our healthcare backlog, which totals almost $500,000,000 at the end of the quarter despite the strong shipments.

Speaker 3

Large projects continue to drive orders representing 40% of 1st quarter orders. We are increasingly competent in our expectations of a strong year for our Healthcare segment. Turning to AST. Constant currency organic revenue grew 5%. Our performance in the quarter was impacted by 2 temporary Situations.

Speaker 3

Inventory destocking in some categories of medtech and the year over year market decline of bioprocessing customer demand. As we said last quarter, FY 2024 represents a bit of a reset and we do not anticipate returning to year over year growth in bioprocessing in fiscal 2024. As for the MedTech inventory destocking, we would not expect that to continue beyond the first half of the year and we anticipate customer inventories at that time will align with the procedural growth we are all experiencing. As a result, our expectations are for stronger growth in the second half of the year for AST. Life Sciences revenue declined slightly in the quarter due to the timing of capital shipments, which more than offset the growth in service and consumables.

Speaker 3

Underlying demand for the business remains strong as evidenced by our near record backlog. Our full year expectations for the Life Sciences This segment continued to be mid single digit revenue growth despite the lumpy first quarter start. Our Dental segment first quarter revenue declined 4 on a constant currency organic basis as revenue was limited by customer destocking of inventory, in particular for infection control products. However, we did see patient volumes improve for the first time post COVID. We are confident that we will achieve low single digit revenue growth for the fiscal year in dental.

Speaker 3

All in, we are pleased with the start to the year. Trends continue to shift in a positive direction and our ability to execute Ship products has greatly improved. There are still pockets of uncertainty, whether that be supply chain, procedure volumes or inventory management. As mentioned in our press release, we believe that the acquisition of the surgical instrumentation assets from Becton Dickinson will close much earlier than we originally anticipated. As a result, we have updated our outlook for as reported revenue, adjusted earnings per share and free cash flow.

Speaker 3

We are feeling increasingly optimistic about our constant currency organic performance for the year. Yet, we are still holding our outlook to 6% to 7% growth. We acknowledge that this is a somewhat conservative approach given our start to the year. That concludes our prepared remarks. Julie, would you please give the instructions

Operator

Yes, ma'am. Before pressing the keys. And at this time, we'll pause momentarily to assemble our roster. And the first question will come from Matthew Mishan with KeyBanc. Please go ahead, sir.

Speaker 4

Hi, Hi, good morning and thank

Speaker 5

you for taking the questions and a really nice quarter to start the year. Dan, I first wanted to start On the capital equipment, as you kind of think about how you had contemplated the phasing of your guidance, did you pull forward Some capital into the Q1 with excess shipments? And also how are you thinking about The order environment versus the shipments. I'm assuming it's not one for 1 and you are thinking about bringing that backlog down in FY 2024.

Speaker 3

Yes, sure. Thanks. That's correct. What I would say is we over delivered in terms of What we had anticipated from a manufacturing perspective in Q1, we've been bidding a bit on the supply chain issues over past year and so we're trying to do everything possible to manage our customer demand where they actually need the product now. And we did a better job in delivery.

Speaker 3

So that pulled forward some revenue that might otherwise been in Q2. But generally speaking, our ability to Produce and deliver is getting better and our lead times are coming down across all of our capital equipment portfolios. And in terms of the orders intake, yes, there is a point at which you will start to see declining backlog, obviously, as we get back to much more normalized delivery times. With the only caveat being there some of the large projects stuff, Matt, that's got longer lead.

Speaker 5

Okay. And then I have 2 more on the task and both upfront. Is and I didn't catch it, but is the phasing 1H, 2H still $4,555 from a revenue and EPS perspective? And then secondly, Can you comment a little bit more around the drag from destocking, especially in some categories of medtech? It Seems a little bit counterintuitive when you think about the current environment.

Speaker 3

Yes, we agree. First off, yes, the phasing remains as originally anticipated. And in terms of the destocking that we're seeing in MedTech, we really started to see it in Asia Pacific, in particularly around some sterile PPE. And some of that, was foreseeable given that the national stockpiles have been filled and all that demand sort of went back to normal levels. What we're a little surprised of is that we're seeing a pullback on our customers' level of inventory.

Speaker 3

Now having said that, we shouldn't be surprised Because we like everybody else have too much inventory right now. So it's and as confidence comes back in terms of your ability to produce and ability to Supplies and supply chain solidifies, the natural thing one would expect is to wring out some of that inventory down to levels that are Matching demand. I don't think that process is going to take too long. I think it's been going on for a period of months now. And then I think what you'll see is the inventory demand align with the procedure rates, which are clearly Higher.

Speaker 3

So Matt, I agree with you that the 2 seem in opposite directions in terms of what we're seeing in Healthcare, in particular, in our Healthcare Consumables business. We know that our customers are seeing the same thing. I think they've just got to wheel down some inventory.

Speaker 5

Thank you very much, Dan.

Operator

The next question will come from Dave Turkling with JMP Securities. Please go ahead.

Speaker 6

Great. Good morning. Good morning.

Speaker 5

Just looking at the

Speaker 6

healthcare number and the Capital One,

Speaker 5

That I'd like to press you

Speaker 6

a little bit there and say, how are you reducing these lead times? And you called out market share gains. I'm wondering if there's Are there any new products or anything you'd highlight and how you put up a number left like that?

Speaker 3

Well, I mean, Dave, we're working off of a monster backlog that spilled into this fiscal year, and we had some challenges producing. And as we got parts in, our teams were ready and we were able to push up stuff down the line pretty quickly. And We would expect that to continue in terms of our ability to deliver on that backlog. So I wouldn't highlight any single product or any Small group of products in terms of new products or anything like that. It's just generally speaking, I think our portfolio is in a really good spot in terms of how it's positioned, not just on a competitive basis on a product by product, but also as a total portfolio in terms of what we can offer.

Speaker 6

And so we think of the market share gains as sort of across the board or is there anything like more specific there that you were Kind of calling out in any arena?

Speaker 3

Not specifically. I would tend to say We're in a really good position in sterile processing right now in our Infection Prevention Technologies Group. But I think we're in a good position as well in Other areas of healthcare, but IPT right now I think is really doing, carrying a lot of

Speaker 6

the load. No. Congrats. Thanks.

Operator

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

Speaker 5

Yes, thanks. I just had

Speaker 7

a couple questions on the Becton Dickinson deal. Can you maybe talk about the growth that that business We've had in recent years. And then, I know you gave us kind of the EBIT margin, but what about the gross margin of that business? How does that Compared to your kind of corporate gross margin.

Speaker 2

Yes. I would say that, Mike, on On the gross margin side, it's similar. The growth rates would be similar in our long term view of healthcare mid to high single digits as we bring that portfolio of products into our Healthcare segment. It's 100 percent Healthcare. So I would say not much different from what we currently Have from a margin perspective, both gross margin and a little bit it's actually a little bit higher on the EBIT margin standpoint.

Speaker 2

Unfortunately, We are going to incur in the short run higher interest expense. I think as I looked at some of the models that were out there, I don't think everybody appreciated that we are going to use our full revolving credit facility for the $540,000,000 which is equivalent to about $25,000,000 in interest expense this year. So I think there is a little bit of a Slower ramp because of that interest expense, but once we clear some of that expense out, we'll be back to what I'll call normalized Healthcare

Speaker 7

Margins. Okay. Thanks. That's helpful. And then, I didn't hear you quantify the inflation impact.

Speaker 7

I know last Fiscal year, you were kind of given that every quarter. And then just related to that, you'd also called out lower productivity in terms of your gross margin. So I don't know if you can comment on either of those things or quantify them.

Speaker 2

Yes. So we originally anticipated this fiscal year that we would have about $30,000,000 and we've Using the term excess material labor inflation, we incurred $10,000,000 of that $30,000,000 in the Q1.

Speaker 7

Okay. And the productivity lower productivity that you called out, can you talk about that or?

Speaker 2

Yes, we really haven't quantified that, but we are having the Same issue that we've had in the past, right? So we are touching our products multiple times as we're waiting on the parts. So that productivity should improve throughout the year, which will help not only our gross margin, but also get more of our EBIT margin back to flattish, Which is where our original guidance was for FY 2024.

Speaker 7

Okay, got it. So that's just sort of

Speaker 5

a byproduct of the Supply chain challenges.

Speaker 6

Correct.

Speaker 7

Okay. Thank you. You're welcome.

Operator

The next question will come from Steven Itauch with Stevens Incorporated. Please go ahead.

Speaker 8

Good morning. This is Mac on for Jacob. Just a couple quick questions for me. Despite a sequential revenue decline, dental margins increased sequentially. What is the outlook for margins in this segment?

Speaker 3

I'm sorry, what was the question? Dental margins. Dental margins.

Speaker 1

What should they be long term?

Speaker 2

Yes. Long term, we said they should get they should rise to Near the corporate average, and you are seeing that they are getting much more operationally efficient, which is really helping drive That EBIT margin improvement, there is still a way to go, but we are happy more than happy with the progress that they are making within that segment.

Speaker 8

Thank you. And sorry, if you can't hear me, just let me know. I'll repeat the question. But Healthcare operating margins,

Speaker 4

They are

Speaker 8

the highest it's been in some time and 2 solid quarters in a row. Are there any one time benefits? Or is this a good run rate going forward?

Speaker 2

Obviously, volume is the biggest driver at this point in time. We have seen our Healthcare Segment operating margins continually to increase. I don't know if we're ready to say this is The new high and building off of there, but we are very pleased where we are at. And as we continue to put more volume through and as the mix, Especially the mix on the consumable side, if that continues to remain throughout the year, obviously, there is still potential upside for those margins.

Speaker 8

Great. Thanks for taking my questions.

Speaker 3

Thank you.

Operator

The next question will come from Patrick Wood with Morgan Stanley. Please go ahead.

Speaker 9

Amazing. Thank you. I'll keep it to 2 and I'll just ask them both upfront if that's easier. I guess the first one, obviously, everyone's talking about the big capital equipment number. I'm just curious like how the conversation with your customers Appreciate that some of this is working through the backlog and lead times on your end.

Speaker 9

But presumably, it seems like the customers are in pretty healthy place They're willing to be investing on the capital equipment side to that degree. And then I guess the second one is essentially related to that, which is In some ways, the more important component of that capital equipment side is the follow on consumables componentry for the rest of the year. Is it fair to take a look at that strong conversion from the backlog and think about the consumable pull through and the growth on that side, whether it's for the rest of this year or going into next year.

Speaker 3

Yes. Thanks, Patrick. So what I would this is Dan, by the way. What I would say is the conversations with It's interesting because you read, the stress that the health care system, in particular in the U. S, but everywhere else is under financially.

Speaker 3

I I mean the labor costs have gone up 20% in many places and they operate on pretty thin margins to start with, so cash is a challenge. Now having said that, Everybody agrees that procedure volumes are returning, recovering and growing and there's pent up demand. And the STERIS equipment is Seeing more as a utility than it is a luxury, because they can't get the capacity to get instruments through and surgeries process without sterile processing capacity without ORs, without the SPD equipment. So we've knock on wood, we've remained pretty robust in terms of our order intake. And generally speaking, the outlook is pretty strong for that to continue for some period of time.

Speaker 3

And yes, as we place those units And have that real estate in the sterile processing department. The onus is on us to make sure that we get The chemistries and all the other accessories consumables that go along with the steam sterilizer or washer Or an AER, whatever that may be. But the pull through in that is consistently pretty strong and we have a highly focused dedicated channel And in healthcare organization to focus on that.

Speaker 7

Super helpful. Thank you.

Operator

The next question will come from Michael Pollard with Wolfe. Please go ahead.

Speaker 4

Hi, good morning. Thank you for taking the questions. I must say first, I counted 8 minutes of prepared remarks, including the disclaimer. So kudos there. That might be an all time Conference call record.

Speaker 4

My first question, maybe a few parts to it is on AST. With the fresh call out of MedTech related destock, internally, is your Full year revenue expectation for ASP different than it was before?

Speaker 3

No. I think what I would say is that It may be weighted more negative in the front half of the year than we anticipated, and we expect to recover some of that in the second half. I mean, Mike, if not for bioprocessing and the destocking that we're seeing right now, I could say confidently we'd be somewhere in the I don't know, Pick a number between 9% and 12% kind of range is what we would have expected. And I think that those 2 issues sort themselves out by year end, and I think that the healthcare destocking probably sorts it out sooner than year end.

Speaker 4

So two follow ups there on Bioprocess and MedTech. So on Bioprocess, I think this is the 3rd quarter You've called it out year on year. So it's definitely been in the run rate sequentially for at least 2 quarters. My question is, June quarter versus March quarter, did it deteriorate incrementally or is it kind of consistent Q over Q in terms of overall order pattern from those customers.

Speaker 3

It was flattish to the Q4. The reason why it sticks out a little more is it's the comp in Q1 and also in Q2 are the 2 highest the 2 toughest comps for

Speaker 4

us. Yes. And then on device customers, I heard the national stockpile call out, appreciate that. In kind of interventional medicine, let's Say the neuro and cardio and ortho, any categories there that you see as kind of especially Kind of noteworthy in terms of reducing inventory levels or would you call it broad based ex the PPE stockpiling?

Speaker 3

I would say it's broad based, and I would also say there's some that are still surging in building inventory. We see that in ortho and spine and And pain management right now. So, but that's not a huge amount of the volume flowing through our plants necessarily in the grand scheme of things.

Speaker 4

Okay. I hope that was a 3 parter, but I consider that my first topic. My second is more straightforward on BD Transaction, kind of very prudent entry price. So you're seemingly Earning your return on the buy, which is nice to see. Over the mid to longer Do you anticipate revenue and or cost synergies from this portfolio?

Speaker 3

I think mostly I mean, there's some cost synergies, but they're minimal, I mean, in In terms of and it more has to do with scale and leverage on channels and things like that. I do think there's some sell through Synergies, the way that instruments, the BD Instruments marry up with both our instrument repair business as well as Instrument trace and tracking through the sterile processing department. Everything we do in terms of our washers and sterilizers in our infection prevention technologies group Dealing with instructions for use for all types of different instruments. And I think having the instruments available through STERIS, Having the ability to supply, repair and manage the lifecycle through washing and sterilization back to the OR It's a compelling story from a customer perspective.

Speaker 4

Thank you.

Operator

Our next question will come from Jason Bittner with Piper Sandler. Please go ahead.

Speaker 4

Hey, good morning, everyone. Thanks for taking the questions. I wanted to start a little bit with the guidance rationale. You can be consensus by almost $0.15 really strong free cash flow quarter, revenue obviously as we've all About year was really strong, but you elected not to make any updates to full year guidance. I know we're only 1 quarter into the fiscal year.

Speaker 4

It sounds like there Maybe earlier fiscal year conservatism, but can you talk about the pushes and pulls that went into the decision to update or I guess in this case not update core guidance

Speaker 3

Yes. In short, I would say we did a really nice delivery in terms of our Healthcare business this quarter. And we look at that business and we're very optimistic in terms of how they're going to perform over this year. In terms of life science and AST, there's some things that have to get worked out there relative to timing of some of these events. We think we understand the market.

Speaker 3

We think with a high degree of confidence with all the data we have that we know how things are going to play out, but there's no 100% guarantee and there's no 100% accuracy on the crystal ball. So The short answer is, is we're taking a conservative approach. And if things continue to do great, we'll have a different conversation sometime in the future.

Speaker 4

Okay. All right. Makes sense. And then I wanted to come back to the dental business as well here. The core growth has been flat to down for, I think, 4 consecutive quarters now.

Speaker 4

So the commentary obviously getting easier here going forward. But Maybe looking backwards first, are there actions you're taking or you have taken in exiting unprofitable areas or shutting down certain SKUs? And I really ask just because the performance we've seen so far does seem like it's running a little bit below market. So I'm trying to figure out if there's maybe some self What the pain here that has a positive ROI or if you see any other factors is contributing to the weakness for that segment, Again, relative to maybe the market or your peers. And then just as a follow-up here on a 2 parter, what contributes to the optimism of getting back That business back to low single digit growth given where it's been trending here?

Speaker 3

Yes, a couple of things. I would say, I think that we have a little more exposure than some of our peers per se because of the amount of PPE and infection control that is almost half of the business, the STERIS Dental business. And that type of stuff got way overbought and overstocked and it needed to get burned down. And also the comparisons of how much was being used A few years ago versus now, it's a different time and a different world as it relates to that type of stuff. What I would say is on the instrument side, the Hugh Fritty brand stuff Doing really well in terms of growth and we would expect that to continue.

Speaker 3

And we would expect to see innovation from a product perspective and So cost management from manufacturing and delivery perspective. And the team in their demo group has done a really nice job managing the OpEx Until we see the market recover as well and making sure that we're not overspending.

Speaker 4

All right. Thanks so much.

Operator

The next question will come from Matthew Mishan with KeyBanc. Please go ahead.

Speaker 5

Hey, great. Thanks for taking the follow-up. I just wanted to talk about like longer term GI procedures. One of the larger hospital systems Was saying that they're realizing pent up demand, seeing a lot of strong growth for GI and endoscopy. And one of the factors they're starting to see is like a change in guidelines, reducing the age for, I think, colon cancer screening down to 45 or 50 and that's starting to play through.

Speaker 5

I was just hoping you could talk a little bit about your endoscopy business, some of the Cantel factors and kind of how you're looking at that over the next year to 2.

Speaker 3

Yes. What I would say is that The drivers in terms of the 45 age recommendation has helped. I mean, it does open up for a lot more screening. The sort of the governor on that For the past, I don't know, up until about a quarter ago or 6 months ago, it was really healthcare staffing and their ability to get colonoscopy scheduled. I know that I personally tried to schedule 1 in December and they told me the soonest I could get in was the end of February.

Speaker 3

So I think a lot of that's been sorted. So it does have an impact and that is reflected in particular in both our capital Equipment with all the AERs that we sell, but it also is a major contributor to why we had such strong delivery in Healthcare Consumables in the Q1.

Speaker 5

And then a follow-up on the corporate and other, I believe you mentioned that it was in incentive comp and a reset That's a concept that helped drive that. Is that type of year over year increase from a dollar perspective something we should be modeling in over the next

Speaker 2

Yes, Matt, if you recall, we called out last quarter that we will have a $40,000,000 hole, if you will, that we have to fill From an incentive comp expense year over year. So that is a big driver of that Increase in corporate expense. A couple of the other drivers in there, we also opened a new distribution center in Indianapolis, Indiana. So that is also at additive cost. And then one of the other things that we're seeing is our usage of our employee healthcare benefits Is on the rise, so we're also incurring slightly more expense there.

Speaker 2

So those are the 3 main components that we saw in the Q1, but for sure That $40,000,000 we called out last quarter.

Speaker 5

Thanks, Mike.

Speaker 2

You're welcome, Matt.

Operator

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

Speaker 1

ahead. Thank you, everybody, for taking the time to join us this morning, and we look forward to seeing many of you out on the road this fall.

Speaker 5

The conference

Speaker 7

is now concluded. Thank you for attending today's presentation.

Operator

You may now disconnect.

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