STERIS plc (NYSE:STE) Q2 2024 Earnings Call Transcript

STERIS plc (NYSE:STE) Q2 2024 Earnings Call Transcript November 8, 2023

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. [Operator Instructions]. Please also note, today’s event is being recorded. At this time, I’d like to turn the floor over to Julie Winter, Vice President of Investor Relations. Ma’am, please go ahead.

Julie Winter: 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 Carestio, 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. Some of the statements made during this review are 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. 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 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.

Mike Tokich: 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 second quarter performance. For the quarter, constant currency organic revenue increased 8% driven by volume as well as 330 basis points of price. Gross margin for the quarter decreased 50 basis points compared with the prior year to 44.3%. The favorable price was more than offset by lower productivity and continued material and labor inflation. EBIT margin decreased 130 basis points to 22.5% of revenue, compared with the second quarter 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%.

Net income in the quarter was $202.2 million and adjusted earnings were $2.03 per diluted share. Capital expenditures for the first half of fiscal 2024 totaled $149.9 million, while depreciation and amortization totaled $290.2 million. We are adjusting our capital spending outlook for fiscal 2024, down from $375 million to $310 million. This change reflects the timing of projects for our 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 million. Debt increased to $3.4 billion in the second quarter, reflecting borrowings to fund the acquisition of the BD assets. Total debt-to-EBITDA at quarter end was approximately 2.3x gross leverage. Free cash flow for the first half of fiscal 2024 was $284.7 million as we benefited from lower capital spending and a decline in cash used 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.

Dan Carestio: Thanks, Mike, and good morning, everyone. Thank you for making the time to join us to hear more about our second quarter performance and our outlook for the rest of the fiscal year. As you heard from Mike, our second quarter 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. 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 were able to ship at a faster pace than new orders are coming in as we get back to normal lead times for our customers. 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 face very challenging comparisons in the fourth quarter. 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.

In addition, our performance in the quarter continued to be impacted by two short-term situations; inventory destocking in the Medtech space and the year-over-year market decline of the bioprocessing customer demand. We do see very positive signs of recovery in the Medtech demand. 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. From a bioprocessing perspective, as we have said, FY ’24 represents a bit of a reset, and we do not anticipate returning to year-over-year growth in bioprocessing in fiscal 2024. As we head into the second half, our comps ease as it was the third quarter of fiscal 2023 when we first witnessed declines in bioprocessing.

Based on these factors, our outlook continues to reflect very strong growth in the second half of 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 first quarter 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. We continue, however, to be very optimistic about the long-term trends driving demand for aseptic manufacturing in biopharma. Our Dental segment, second 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.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 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 fourth 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. Julie, would you please give the instructions and we can start the Q&A.

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

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Q&A Session

Operator: Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions]. Our first question today comes from Johnson Jacob from Stephens. Please go ahead with your question.

Jacob Johnson: Hey, good morning. Thanks for taking my 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 is going better than expected. Can you just talk about the other three segments and where things have changed the most? I think reading the material, Dan, maybe it seems like Life Sciences is 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?

Dan Carestio: Yes. 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 doing a $3.5 billion cut. And other — some other pharma companies are sort of following suite. So generally speaking, we see — when we see that start to happen, there’ll be a short-term pullback in the industry. But the long-term outlook for biopharma and aseptic manufacturing, which is really our sweet space is 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 quarter, 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. There’s been a lot of strikes and 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 doesn’t eventually, they’re going to burn down the inventories and access that they have sitting around. And I would have expected that around the time that we saw it in the U.S., I think as I’ve mentioned in previous calls, we expected 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. Last year, Q2 was our high point, and then we started seeing it slowing in Q3 and ultimately sort of bottomed out by Q1 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 fiscal year.

Jacob Johnson: 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?

Dan Carestio: Yes, 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, in particular, that slipped till the end of the quarter and didn’t get recognized until this quarter. So that’s just purely a timing issue, and orders remain pretty strong. And we’ve just been able to get a lot more stuff out of our factories as we bring our lead times down pretty significantly. So we just had a great delivery quarter for capital and general cross-post businesses.

Jacob Johnson: Got it. Thanks for taking my questions.

Dan Carestio: Sure, thanks.

Operator: Our next question comes from Dave Turkaly from JMP Securities. Please go ahead with your question.

David Turkaly: Hey, good morning. 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 of projects for AST. I’m just curious, is there a shift going on between some of the modalities there? Or what exactly the Medtech customer inventory that you’re highlighting are you seeing?

Dan Carestio: Well, like I said, we have seen 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 two or three quarters. It’s taken a bit longer for that recovery to happen outside of the U.S. The plants are busy in North America, and they’re not as busy 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.

Julie Winter: And Dave, the shortages, I think, have been more tied to EO sterilization.

Dan Carestio: Yes.

Julie Winter: Where our softness has been on the radiation side.

Dan Carestio: Yes.

David Turkaly: 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 is first, but I don’t know how to sort of analyze that or what you think that will mean for you moving forward?

Dan Carestio: 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(k) would not have to do a refile effectively. They would enter under our master file program. 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 a much more resiliency and also switch between technologies.

David Turkaly: Great. Thank you.

Operator: Our next question comes from Michael Polark from Wolfe Research. Please go ahead with your question.