STERIS plc (NYSE:STE) Q3 2024 Earnings Call Transcript

STERIS plc (NYSE:STE) Q3 2024 Earnings Call Transcript February 8, 2024

STERIS plc isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning everyone and welcome to the STERIS plc Third Quarter 2024 Conference Call. [Operator Instructions] 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.

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 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. 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 third quarter performance. For the quarter, constant currency organic revenue increased 10% driven by volume as well as 270 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. EBIT margin decreased 80 basis points to 23.1% of revenue compared with the third quarter 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 to the Healthcare segment impacted EBIT margins.

We anticipate that the mix shift in operating income from AST to Healthcare will continue in the fourth quarter. The adjusted effective tax rate in the quarter was 22.6%. Net income in the quarter was $220.9 million and adjusted earnings were $2.22 per diluted share. Capital expenditures for the first 9 months of fiscal ’24 totaled $268.8 million while depreciation and amortization totaled $430.8 million. Debt declined slightly to $3.3 billion in the third quarter. Total debt-to-EBITDA at quarter end was approximately 2.2x gross leverage. Free cash flow for the first 9 months of fiscal 2024 was $457 million compared with $262.8 million for the first 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, I will turn the call over to Dan for his remarks.

Dan Carestio: Thanks, Mike and good morning, everyone. Thank you for taking the time to join us to hear more about our third quarter performance and our outlook for the rest of the fiscal year. As you heard from Mike, our third quarter continued the momentum we have experienced in our Healthcare segment in the past few quarters and we also saw a nice improvement in Life Sciences. Overall, we are pleased with our performance. 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. 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. While we have continued to see more normalized volumes in the U.S. for medtech, outside of the U.S. remains softer than anticipated. In addition, bioprocessing volumes continue to contract. Until we have more clarity, we are taking a more conservative approach to our expectations for the fourth quarter.

Life Sciences grew 20% in the quarter on a constant currency organic basis. We had another strong quarter of capital shipments which grew 57% against relatively easy comparisons. Remember, in fiscal 2023, revenue for both capital equipment and consumables was shifted from the third quarter to the fourth quarter due to some supply chain constraints. 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 third quarter revenue declined 6% on a constant currency organic basis. Revenue is limited by reduced orders from a large customer 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. 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 to compensate for challenges elsewhere. 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 and 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 fourth quarter caused by the record-setting shipments in last year’s fourth quarter. 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. We recognize this outlook includes some conservatism but believe it is warranted until we see the AST customer destocking abate and 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&A.

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

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Q&A Session

Operator: [Operator Instructions] Our first question today comes from Patrick Wood from Morgan Stanley.

Patrick Wood: 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. 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 1/3 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?

Dan Carestio: 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 two things. One 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. 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.

Mike Tokich: 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 third quarter. So strong shipments in the quarter but also good outlook with that double-digit growth in orders for future.

Patrick Wood: Amazing. And then maybe just quickly on AST. I guess within bioprocessing, the companies there 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. Is that something that you think resonates with you as you move through the next few quarters, like things on the bioprocessing side get a little bit better? And then equally within AST, 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?

Dan Carestio: Yes. We would have thought that too, Patrick. So what I would say is that we’ve seen the turn in the U.S. market, for the most part, in medtech destocking. And that’s a function of the efficiency of the healthcare systems over here and procedure volumes up being up significantly. They’ve been able — our customers 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. 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 in 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.

Patrick Wood: Having been treated in both the U.K. and the U.S., I’m glad I live here from healthcare perspective.

Operator: Our next question comes from Brett Fishbin from KeyBanc.

Brett Fishbin: 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?

Mike Tokich: 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 million headwind. The bulk of that, about $22 million of that was impacted in the third quarter. 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. 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, 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 reducing our backlog and getting back to more normalized lead times.