Q2 2023 STERIS plc Earnings Call
Good morning, everyone and welcome to the stairs plc second quarter 2023 conference call.
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At this time I'd like to turn the conference call over to Julie Winter Investor Relations Ma'am. Please go ahead.
Thank you, Jamie and good morning, everyone.
As usual all speaking on today's call will be Mike tickets.
Senior Vice President and CFO , and Dan Christiana, <unk>, our president and CEO .
And I do have a few words of caution before we open for Cameron.
This webcast contains time sensitive information that is accurate only as of today any redistribution retransmission or rebroadcast of this call without the express written consent is strictly prohibited.
Some of the statements made during this review are or maybe considered forward looking statements.
Important factors could cause actual results to differ materially from those in our forward looking statements, including without limitation those risk factors described in our 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.
Theres just a 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 yesterday's release.
Also including 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.
Those questions I will hand, the call over to Mike.
Thank you Julie and good morning. This 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 7% driven by volume as well as 290 basis points of price.
As anticipated the divestiture of the renal care business impacted our comparisons to the prior year by about $45 million as detailed in the press release tables our.
Our year over year growth rates will be impacted by this divestiture for one more quarter.
The integration of catch all medical continues to go well, we achieved approximately $15 million of cost synergies in the second quarter, bringing our first half total to about $35 million. We are on track to achieve our stated goal of approximately $50 million in fiscal year 2023.
As anticipated gross margin for the quarter decreased 140 basis points compared with the prior year to 44, 8% as pricing currency and the favorable impact from the divestiture of renal care were more than offset by lower productivity and higher material and labor costs.
Labor costs continue to be a headwind and totaled about $30 million in the quarter.
Despite the decline in gross margin EBIT margin increased 50 basis points to 23, 8% of revenue compared with the second quarter of last year, which reflects the benefit of realized cost synergies from the cantel integration currency impact and lower than anticipated SG&A expenses, driven by disciplined cost management.
The reduced incentive compensation.
The adjusted effective tax rate in the quarter was 22, 8%.
Net income in the quarter increased to $200 million and earnings were $1 99 per diluted share.
You will notice that we reported a loss on a GAAP basis in the quarter.
At the time of the Cantel acquisition, we determined the fair value of the dental segment based on projected cash flows discounted at rates, reflecting market cost of capital and market EBITDA multiples.
Economic conditions, including rising interest rates inflationary pressures on material and labor costs and uncertainty regarding the impact of such economic strange may have on patient and customer behavior in the short term triggered an interim assessment of goodwill in the quarter.
<unk> cash flow projections at a current market weighted average cost of capital resulted in an estimated fair value of the dental segment below its carrying value.
Therefore, we recorded a $496 million noncash impairment charge related to the goodwill associated with the dental segment.
Our long term outlook for the dental segment is unchanged and we continue to see significant growth opportunities in the dental space for cerus.
Capital expenditures in the first half of the fiscal year totaled $198 $7 million, while depreciation and amortization totaled $272.7 million year to date, our capital expenditures have been higher than anticipated, primarily driven by the timing of investments and the a S. T segment.
We still expect our full year capital expenditures to be approximately $330 million.
Free cash flow for the first half of the year was $138 $2 million free cash flow was limited by higher than planned capital spending mainly due to timing and higher than planned levels of inventory. We do not anticipate the same level of spend in the second half of the fiscal year for either which are.
Contribute to a significant step up in free cash flow.
All in we now anticipate that free cash flow for the full year will be about $600 million or reduction of $75 million from our original guidance I will now turn the call over to Dan for his remarks.
Thanks, Mike and good morning, everyone. Thank you for taking the time to join us to hear more about our second quarter performance and our outlook for the rest of the fiscal year.
We continue to see strong demand for our products and services and as you you've heard from Mike We had a solid quarter. Despite the ongoing macroeconomic challenges.
I will review the highlights of the quarter and then shift my commentary to our outlook.
Total company constant currency organic revenue growth was 7% in the quarter. Once again foreign currency was more impactful than previously planned on our as reported revenue, but we are pleased with our operational performance.
From a segment perspective health care constant currency organic revenue grew 7% in the quarter.
As we discussed last quarter by August we had an improved visibility on supply chain challenges and that we anticipated that we would start to see better component deliveries in the quarter.
We received several key components and we're able to step up our shipments in September .
We continue to expect to see significant levels of capital shipments in the second half based on our backlog the.
The inventory of key components that we have or will continue to receive.
Reflecting that scenario capital equipment and service growth remains solid in the quarter as we continue to see good demand from our customers consumables were about flat on a constant currency organic basis.
Our consumable growth is limited due to a lack of procedure growth on a year over year basis.
As we have said before we do not expect a significant pickup in procedures in the coming months, but we are optimistic we will get back to a 100% pre pandemic levels overtime.
Hospital capital spending remains robust as evidenced by our health care backlog, which totaled over 500 million at the end of the quarter.
Orders for the quarter were approximately 60% for replacement products and 40% for large projects.
Despite the uptick in shipments at the end of the quarter, we believe approximately $60 million in capital equipment shipments were delayed in our second quarter further strengthening our confidence in the second half.
Yes.
Longer term our portfolio upstairs is essential to surgeries either directly in the operating room or in the core support sterile processing Department.
And we believe this provides us some insulation to our revenue base from our customers rising cost of capital.
Moving on to a S T.
A S. T grew constant currency organic revenue, 19% in the second quarter as we continue to benefit from underlying demand from our core customers.
In the second quarter <unk> improved significantly on both the year over year basis, and sequentially, which pushed our growth rate into the high teens.
As you have already witnessed shipments can be lumpy with this segment of the business similar to life Sciences. These are large pieces of capital equipment that are not booked as revenue until they are fully installed and tested.
From a profit perspective increased energy cost both in the U S and internationally are impacting margins for E. S T.
All signs indicate that this will continue at least through the winter.
We continue to look for ways to recoup these cost as the contracts allow and the timing of our increases.
Life Sciences revenue was flat on a constant currency organic basis compared with the prior year.
Solid service revenue growth was offset by declines in both capital and consumables.
We believe capital equipment shipments or just a matter of timing, that's about $10 million slipped into the third quarter versus our expectations and as a reminder, the business had a very strong shipment quarter in Q1.
Also our backlog continues to hover around 100 million.
We are optimistic about the long term demand for our capital equipment in this segment.
On the consumable side, we were about flat from a constant currency organic revenue perspective.
This is primarily due to inventory management by our customers in particular and our barrier products line.
I'm not concerned about the long term underlying trends for the business as a septic pharma production demand remains very strong.
Our dental segment declined 3% on a constant currency organic revenue perspective.
While procedure volumes for dental continue to hover around 95% of pre COVID-19 levels year over year pursuit procedures have declined in the low single digit range.
We believe this is due to the current macroeconomic conditions.
Despite the decline in revenue operating margins were over 25% as we manage spending and experienced some relief on our supply chain cost.
Yeah.
Turning to our full year outlook constant currency organic revenue growth expectations of 10% remain unchanged.
However, based on the ongoing foreign currency challenges, we are revising our as reported revenue.
As reported revenue is now expected to grow 8%.
A reduction of 1% from the prior expectations due to continued foreign currency fluctuations.
For the year currency is now expected to reduce as reported revenue by $150 million in.
And adjusted EPS by approximately 15 cents.
The primary drivers of this continue to be the weak euro and British pound.
Reflected in our revenue outlook is improved pricing, we are now expecting around 250 basis points for the year.
Combined pricing and disciplined spending will contribute to higher than planned operating margins for the fiscal year.
This will help offset the impacts from foreign currency and additional supply chain inflation.
For the year, we now expect an incremental $90 million, an extra ordinary supply chain and labor cost inflation, an increase of $20 million over our prior expectations.
Factoring in these elements our expectations for earnings are unchanged at the $8 40 to $8.60 range for the full fiscal year.
However, with an additional 5% impact from foreign currency, we believe the high end of that range is less likely.
Overall, our business continues to perform very well in this environment, our teams and portfolios continue to come together to better meet the needs of our customers and the breadth of our offering allows us to take advantage of several significant trends in the industry by leveraging our relationships to cross sell within business segments.
And deliver value to our customers.
Before we open for Q&A I did want to address the challenges the industry is facing on ethylene oxide.
As you all know ethylene oxide is essential to the supply of sterile single use medical devices throughout the world too.
To date the industry does not have an alternative G E O and currently in the U S. There is very limited capacity to manage the long term growth expectations for the medical products industry as demand for ethylene oxide processing technology.
[noise] at stairs, we take our responsibility very seriously as a provider of these crucial services and have always been committed to strict regulatory compliance and quality standards for the safety of our people our facilities and the communities in which we operate.
We are stewards of the long term success of our business, which I believe is exemplified by our actions.
We are regularly updated our processes and equipment news within our facilities to reflect the adoption of new technology and deploy the best practices possible.
In addition, we have led the industry in developing sustainable Eo cycles, which significantly reduced the amount of video gas use per cycle and we've worked closely with the U S. F D. A to right to ease the regulatory transition for our customers. So they can more easily adopt these cycles.
This diligence is consisted consistent with the way we have operated our contract sterilization business for many years I am confident in how we have run and continue to run these facilities and the improvements we have made to our process within the a S T segment.
With that I'll turn it over to Julie to begin the Q&A.
Thank you, Mike and Dan for your comments, Jamie can you give the instructions and we'll get started on Q&A.
Ladies and gentlemen at this time, we will begin that question and answer session.
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Once again that is star then one to join the question queue, we will pause momentarily to assemble the roster.
And our first question today comes from Matthew <unk> from Keybanc. Please go ahead with your question.
Good morning, and thank you for taking the questions.
Just first how should we think about the second half acceleration in organic growth and kind of what are the key drivers around that.
Okay.
The main driver is as we continue to talk about is a capital equipment shipments in particular in our health care segment.
That is really going to be the factor that drives us from about 7% constant currency organic revenue growth to 13% constant currency organic revenue growth around there to achieve our 10% for the full year. So it's all it's all driven by our ability to shift capital equipment and health care.
How do you secure the components necessary. So that you do have the confidence that you will be shipping this.
Hi, Matt. This is Dan I would say, we have a lot more confidence today than we had three months ago, you know theres no guarantees as it relates to the current environment with supply chain.
But we do have a lot now that's in stock and we are aggressively ship shipping as we can finish off machines and and I think that in terms of level of confidence from our suppliers that those shipments will continue to come in and are more protective predictable fashion.
Fashion is pretty high.
And then lastly does it or does it require a an inflection in dental or is it is it possible, but you're still going to get the 10% with dental like remaining flat to down.
We believe the dental business is gonna stay suppressed until procedures come back and you know I think that's tough to predict when that's going to happen given that these are highly elective and.
Currently with inflation and everything else. It's a it's something that we believe is good we've got it modeled to stay where we were without it year to date more or less.
Alright, Thanks, Dan Thanks, Mike.
Yeah, Matt.
Our next question comes from Mike Matson from Needham and company. Please go ahead with your question.
Yeah. Thanks.
I wanted to ask about the there was kind of a big difference in the growth between the S. T business and then the consumables on the health care side and you know since I would assume a lot of the S. T volume as medical devices that are getting used to procedures or maybe will get used in procedures. Eventually you know how do you.
Explain that if you do you believe that we're still below pre COVID-19 levels in terms of procedures, which kind of hurt your consumable.
Growth in health care, but a S. T was still really strong.
Yeah, I mean, it's there's three components of revenue right I mean, there's there's price there's share and then there's just volume growth and what I would say is generally speaking for medical products.
We've seen some recovery in terms of higher end higher value, whether that's neuro or whether that's mine or whether that's worth though we have seen some recovery in those procedures general surgery, we haven't seen any difference in fact, it's still it's still hovering at this.
Pre COVID-19.
Got back to those pre COVID-19 levels, and that's largely a function of staffing in the health care network.
The other side of that as you know we're doing everything we can to recoup price as costs go up in that business. We have a long history of being able to successfully do that with our customers and then the other component is sure. We maybe we picked up a little bit of share over the last couple of years and there's a long tail on that you know in terms of Annualizing those run rates.
And keep in mind too there is a significant portion of our business that's not pure medical products. There is some some level that is bioprocess type disposables in that that that part of the market continues to grow at a pretty high rate and we've been benefiting from that.
Okay got it.
And then in terms of the.
E O regulations, I guess do you have any sense for the timing of when those or would it be Brazil, but then.
Do you how do you feel in terms of where you're at with your P. O practices. I mean do you think there's a potential that you would have to make any changes I mean, it seems like us.
Really put.
Putting into place some pretty rigorous.
Processes to reduce emissions.
But you know I don't know if there's any way to go beyond what you've already done there but.
Yeah, well, what I would say is this.
We expect to see a rule drafts sometime in the first calendar quarter out for public viewing I mean, I've said that before but I think it actually may happen. This time and and so I do expect to see something out in public domain sometime in the first first calendar quarter of the year now having said that you know what I would what I would say is that we have consistent.
We invested and found ways to improve our processes and I would say generally above and beyond the regulatory requirements that are out there.
If I look back in our history a couple of notable examples of those types of improvements would.
Would be where we proactively invested in our abatement technology, you know and this is over decades not in the last 18 months, including upgrading our flares with wet scrubbers and using catalyzed catalytic oxidizer in developing also you know in the last few years, we've installed full abatement systems in our outbound warehouses.
In the U S. A S T locations for for capturing any any potential fugitive emissions, you know within and around all of our E. O Chambers, we have significant safety measures and and enhancements in place, including locks that that don't allow the chamber door to be open until the prescribed amount of E. O. As you know met in terms of the.
Chamber to ensure the safety of our people and maximum capture of ethylene oxide.
And then also a significant.
Thing around the stairs a S T and particularly the U S locations is any of those sterilizers that have or had back events have always Ah repeat always been tied into the emission control systems for maximum destruction of any potential gas coming out of the facility.
Okay got it and then just one on the interest expense it was a little higher and alright.
Or I guess I should say other expense, but I think it's mostly insurance. So it was a bit higher than what we expected is is that because interest rates have gone up and how much of your debt is variable rate.
Don't know if you can give us any guidance on what to expect.
Fiscal year for interest expense, but.
Yeah, Mike.
Definitely the rates have gone up whereas we're all in.
<unk>, 3.6% total, which is definitely higher than where we have been unfortunately a R.
Our projections are that rates will continue to rise currently we sit at just over $3 billion of total debt and it's about 70 30 fixed versus floating is our percentage.
Okay got it thank you.
Youre welcome.
Our next question comes from Jacob Johnson from Stephens. Please go ahead with your question.
Hey, good morning, Thanks for taking the questions.
On the life Sciences segment.
It looks like the.
Backlog growth decelerated this quarter kind of flattish, whereas volumes down can you just talk about demand trends from that end market. It sounds like maybe some of this was related to the timing of shipping orders, but then any thoughts on that end market.
Yeah, I mean as those I'm sorry. This is Dan as those shipments can be lumpy soak in orders because they tend to be pretty high in value.
I'm confident that you know our backlog if we can if we can hold that around $100 million that is that is absolutely outstanding for the long term success of the life science capital business and so on.
I'm I'm happy where it is and in our order intake is strong as well you know as we look into the future side I think we just got to get the stuff shipped out of our plants and we will be working on that diligently over the next six months.
Got it thanks for that Dan and then just circling back on that the dental impairment.
I think some of that's related to the near term performance, but I suspect some of it might be related to rising interest rates can you just talk about those dynamics and then I think you mentioned in your comments no real change to your long term outlook for that business, but I figured I'd ask about that as well.
Yeah, certainly yeah.
I did say at the end of that paragraph in my prepared remarks, Yeah. We believe the long term outlook for dental segment is unchanged and we continue to see significant growth opportunities in that space.
What's really driving that is really what's driving the impairment and we have to look at this at anytime we have any indicating factors.
That goodwill.
It will be maybe a pair the estimated fair value of that segment, maybe below its carrying value and really what's driving that if you use a discounted cash flow model and interest rates and particularly the rising interest rates. In addition to the inflationary pressures, we're seeing on labor and material costs.
I really have two key factors that are driving us to impair all of the goodwill associated with with the dental segment.
Got it.
Thanks for that and thanks for taking the questions.
Youre welcome.
Our next question comes from Jason Bednar from Piper Sandler. Please go ahead with your question.
Hey, good morning, Thanks for taking the questions here and great to hear the progress on the component sourcing the quarter. It sounds like that that's really going to contribute to a nice step up in growth here in the second half of the year I'm Gonna pack a few questions in here on this topic.
Dan can you say, whether those those capital equipment delays late in the quarter that you referenced are you catching up on those real time.
Is there anything we should consider with respect to your capacity to deliver against that backlog because again, that's a pretty big step up in growth just want to confirm that.
And then finally I can't imagine this is a.
It's more aggressive shipping suddenly stops at the end of this fiscal year. So I guess is it right to think of this equipment momentum continuing into fiscal 'twenty four as well.
Okay, Yeah sure. Thanks, Jason.
In terms of your question around capacity, what I would say is this as we've been building machines without components now for <unk>.
For the full fiscal year, basically and because the demand is high we can't lose the manufacturing slot. So you know we we have a number of machines that at the end of the quarter, where we're finished awaiting a $7 part before we can ship it to our customers. So it's not not literally but almost literally yet.
So so we continue to to manufacturer every slot that we have and then finish out equipment as those covenants components show up you know on our docks. If you will so I think we're pretty good shape and we've also historically have shown our ability to flex manufacturing pretty considerably in terms of you look at.
Oracle performance of Stare as you know, we typically have a bigger back half than front half in terms of capital shipments are are our teams are are are able to do that and they have a long history of doing that.
In terms of more of a man I'm going into the next year.
I think that's something that it's hard to look at right now and it's not something we're discussing in terms of our future outlook in terms of what's going to happen in the I mean, we've got we've got six months left to deliver on that's critically important for cerus in our customers right now.
Okay, Yeah fair enough.
That's helpful and then maybe a couple of clarification points.
Mike can you just confirm that the reaffirmed hurting earnings guidance here today contemplates additional rate increase like it looks like we're going to be dealing with you over the coming months and then second point just on the higher inventory levels that are causing.
Cause the free cash flow the free cash flow guidance cut does that continue to those inventory levels continue beyond fiscal 'twenty three do we get a reversal at any point just how do you see that playing out thank you.
Yeah definitely on the on the inventory levels, we've continued to hold higher inventory levels.
All of this year projected the rest of this fiscal year, even last fiscal year. So hard for me to sit there and pinpoint exactly when we will turn that spigot off and once we do obviously, we will see a nice benefit to working capital.
I don't know if that is gonna be in 24 or beyond or timing is it just too hard to predict at this point in time, where we were.
We're just happy to get the inventory components add the ship the equipment for the customer so more to come on that and yes, we did bake in increased <unk>.
<unk> increased interest rates interest rates.
In our forecast so that is already contemplated.
Alright, very good thanks, so much.
Youre welcome Jason.
Our next question comes from Michael <unk> from Wolfe Research. Please go ahead with your question.
Good morning, I want to ask about the back half and then.
24 on equipment, and then maybe one or two follow ups on the back half just as we consider our models 13%.
A real revenue growth for the total company year on year, but December quarter lower than that March quarter higher any flavor you can provide on.
Phasing because.
You know as it clearly the toggle in and the spreadsheet as the health care equipment revenue and it's some pretty big numbers, and it's obviously difficult to predict quarter to quarter. So I think it would be helpful. Just to level set like how you expect this to.
To unfold the next six months between December versus March quarters.
Yeah, and just just looking at it obviously in order for us to meet our intended free cash flow, we need to ship capital equipment earlier. So we can collect so I would say that Q3 would be a little bit higher from a growth standpoint, then Q4 would be if it were modeling this.
But I would also say.
You know to use your words it is difficult to predict and you know in terms of recognition revenue recognition at the end of the quarter.
You know, it's a different world today in terms of getting things are accepted and received around the holiday season, and then maybe it was in the past with labor shortages. So.
We believe we're going to deliver on the year and I think you know trying to be extremely precise from Q3 to Q4 is a little tough right now.
Comps do get them Hey.
Hey, Mike in the fourth quarter, 11% comps kind of mechanically organic last year Q4, So certainly its campus here as well in the fourth quarter.
Are you talking to me up versus my initial stab sequentially. So okay. I will consider I appreciate that comment and then I guess look I understand you're not going to comment on fiscal 'twenty four but these these equipment revenue numbers are potentially.
Very large in fiscal 'twenty, three and I guess, you know we have to take a stab at it.
Publishing.
Fiscal 'twenty four framework N E G.
It just seems kind of.
Reasonable to think total company equipment revenue might you know kind of be down in fiscal 'twenty four on a very significant comp as you unlock the backlog is that you know.
Is that an unreasonable thought.
Keep in mind, a lot of that backlog is in large project that can extend out into you know future fiscal period. So it's the short answer is we don't know right now I mean, the if order rates stay high like they happen then there's no reason why we shouldn't continue to do incredibly well in capital.
If they slow down then that'll impact at I mean, the good thing is is that we have an awful lot of other business in health care.
Tenants due to buoy us on when capital slows or and when capital is going great that helps.
Yeah.
If I could add one more on life Sciences consumables, the kind of inventory management that you called out at production facilities I mean.
What inning do you feel like we're in does that just kind of start and Biopharma are we halfway through the game any any flavor for.
For how long that's been kind of happening would be helpful. Thank you. So much I think yeah I think it's been happening now for a couple of quarters and I think that we'll see a reverse trend in the back half of the year.
Once again, if you would like to ask a question. Please press star and then one.
Our next question comes from Dave took out Joe Kelley from JMP Securities. Please go ahead with your question.
Well get that name right [laughter] good morning.
Maybe just one I've been jumping around so I apologize if somebody hit this but.
Yeah, you mentioned the price again in almost 300 bps.
It's a lot different than a lot of the companies. We cover. So I was wondering if you might be willing to give us a little color either on the divisions or geographies or products or like where it's mainly coming from or any of the drivers. There do you think that's sort of sustainable. Thank you.
You know I think it's sustainable in the sense of we we have an obligation you know as we have sustained higher cost to pass that on.
Wherever we can and wherever our customers can accept it. So that's something that I don't think is going to change and assuming that we consider on this.
We continue on this radar regular relatively high inflation.
Actually when theres certain components of inflation that are unique to stairs in terms of having more meaningful impacts on costs, whether that's electricity or steel or electronics or or things like that so I think that that those trends will continue as long as they need to.
In terms of breakdown on price, but by segments. We don't we don't really weighed into that I mean clearly.
The health care Hospital systems is tougher and some where we have contracts, but as those contracts roll off.
From a GPO perspective, then we'll be incorporating appropriate new pricing levels. The one thing I can say Dave is that we are getting price across all of our segments.
Thank you.
Okay.
Right.
And ladies and gentlemen at this time in showing no additional questions I'd like to turn the floor back over to Julie winter for any closing remarks.
Thanks, everybody for taking the time to join US it will be on the road quite a bit over the next few weeks and we look forward to seeing many of you in person.
Yeah.
And ladies and gentlemen, with that we'll conclude today's conference call and presentation. We do thank you for joining you may now disconnect your lines.