Q2 2024 STERIS PLC Earnings Call
Good morning, everyone and welcome to the stairs P. L. P fiscal second quarter 2024 conference call.
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At this time I'd like to turn the floor over to Julie Winter Vice President of Investor Relations Ma'am. Please go ahead.
Thank you Jamie and good morning, everyone as usual I'll speaking on today's call will be Mike took it sooner.
Vice President and CFO, and Dan Kress, Jr. Our president and CEO and I do have a few words of caution before we open for comments.
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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 questions I live in the call over to Mike.
Thank you Julie and good morning, everyone 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 prior year to 44, 3%.
Favorable pricing was more than offset by lower productivity and continued material and labor inflation.
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 'twenty, 'twenty, four totaled $149 $9 million, while depreciation and amortization totaled $292 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 a S tea 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 two three times gross leverage.
Free cash flow for the first half of fiscal 'twenty 'twenty four it was $284 7 million as we benefited from lower capital spending and the 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.
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 health care segment for the past few quarters. Overall, we are very pleased with our performance in the health care segment and it 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 health care 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 health care.
We are increasingly confident in our expectations of a strong year for our health care segment.
Growth will however, decelerate in the second half as we face very challenging comparisons in the fourth quarter.
Turning to a S T 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.
Inventory destocking in the med tech space and the year over year market decline of the bio processing customer demand.
We do see very positive signs of recovery in the med Tech 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.
For our bio processing perspective, as we have said FY 'twenty four represents a bit of a reset and we do not anticipate returning to year over year growth in bio processing 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 bio processing.
Based on these factors our outlook continues to reflect very strong growth in the second half of the fiscal year for a S. T segment as compared to the first half.
Life Sciences revenue grew 5% in the quarter on a constant currency organic basis as a 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 a septic 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 margin.
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 customer delivery times has greatly improved that.
That said there are still pockets of uncertainty, which remain outside of our health care segment.
We are maintaining our expectations of 6% to 7% constant currency organic revenue growth for fiscal 2024, as we expect a very 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 five sets, which were observed absorbing in our current outlook of $8 $60 to $8.80.
That concludes our prepared remarks for the call Julia would you. Please give the instructions and we can start the Q&A.
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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Yeah.
Okay.
Our first question today comes from Johnson Jacob from Stephens. Please go ahead with your question.
Hey, good morning, Thanks for taking my questions.
Maybe Dan or Mike following up on kind of that the last comment then the 'twenty 'twenty four outlook. It seems like some of the year's playing out as expected and I appreciate the comps but it.
And also it seems like health care are going better than expected can you just talk about the other three segments and where things have changed the most I think reading the tea leaves and 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.
Yeah, I mean, I think we still expect to deliver a good year in life Sciences. There's just there's there's still some continued destocking going on in the space and you see this across you know everybody has reported that sells either tools or disposables into into the Biopharma and pharma industries in general.
It's been announced in the last month or so that you know Pfizer is doing a three and a half billion dollar cut and you know other some other pharma companies are sort of following suit. So generally speaking we see that when we see that start to happen there'll be a short term pullback in the industry, but the long term outlook for for Biopharma, and aseptic manufacturing, which is really our sweet space.
It was really positive and we have a great portfolio and expect to do well.
In terms of.
In terms of the a S. T business you know as I mentioned, we've seen a positive trend in the U S. You know I think the procedures of crossover with sort of the excess inventory that was out there in the past quarter and we're seeing very positive growth from a med tech customers and in terms of Europe, it's taken a bit longer for that to happen you know theres been a lot of strikes and theirs.
Spent a lot of labor shortages in Europe.
And just have not mobilized you know health care delivery in many places the way the U S has to date eventually that that will abate and events and even if it doesn't eventually they're going to burn down the inventories in excess they have sitting around and I would 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 expect that 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 few months not quarters at this point.
And then I think we've covered bioprocess links last year Q2 was our our high point and then we started seeing it slowing in Q3, and ultimately sort of bottomed out by Q1 of our fiscal year, you know give or take so the comps get easier for us in the second half for that are in terms of our performance, especially.
As we get into Q4 and next fiscal year.
Got it thanks, thanks for all that.
I guess my follow up just on backlog, both health care and life Sciences down sequentially.
Is it fair to say health care is more about kind of execution and you are catching up on lead times, and maybe life sciences, a little bit of a macro or anything else you'd share on that.
Yeah, 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 slid until the end of the quarter and didn't get recognized until this quarter. So that's just purely a timing issue and orders remained 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.
<unk> pretty significantly so we just had a great delivery quarter for capital in general across both businesses.
Thanks for taking the questions.
Sure thing.
Our next question comes from based or Kelly from JMP Securities. Please go ahead with your question.
Hey, good morning.
I just wanted to ask one follow up on the ASP side.
Excuse me we have some companies that are saying demand is super high there actually like experiencing bottlenecks to get devices sterilized and you mentioned the timing of projects raised here and I'm. Just curious is there a shift going on.
You know between some of the modalities there what what exactly.
The med tech customer inventory that you're highlighting.
Are you seeing.
Yeah.
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.
First of all what we saw for the past two or three quarters.
Taken a bit longer for that recovery to happen outside of the U S. Yeah. The plants are busy and North America.
And they're not as busy I would get I guess is what I would say outside of that outside of the U S. We expect that to change in the next quarter or so.
And David the shortages I think had been more tied to ill sterilization burdens.
Where our softness is on the radiation side yeah.
No that makes sense.
And then maybe just a follow up for Julie.
The team that master file the pilot program.
I'm just curious as to you know what what do you think that means for you. Obviously I think you said it.
Theres this first but I don't know how to sort of.
Analyze that or what do you think that'll mean for you moving forward yeah. 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 E O to X ray or gamma to X ray or even E beam to gamma or even to switch within our network of <unk>.
Neither our facilities or or technologies without having to do a massive re file from a regulatory perspective. So products that are either under 500 10-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's it lowers a significant regulatory.
<unk> hurdle I would say.
That allows customers to build a much more resilience resiliency and also switch between technologies.
Great. Thank you.
Thanks.
Our next question comes from Michael Pollard from Wolfe Research. Please go ahead with your question.
Hey, good morning.
M. A S. T question for the back half. It obviously the segment has the med backs in it and you break it out. So that's helpful. Not a lot of methanex in the front half can you help level set how much mathematics, you expect in the back half.
In the second half it would be less than a less than $15 million of total revenue first the first half which was about $3 million.
So again not material, but unfortunately year over year, the percentages are large but the dollars are not yep.
Yep.
No. That's helpful and then on the S. T services phasing look I hear all the.
The destock comments and it sounds like light in the tunnel, especially in the U S devices in bioprocess worst of it.
Annualized in now.
Hum.
I'm looking at a S T services in the front half up 5% year on year.
Well, it's kind of a good a good.
Either a sequential growth rate or or year on year growth rate to planned for in the back half.
Yeah in the second half like we expect double digit low double digit growth rates getting back to more normalized.
In the a S T services line the AFC services line exactly okay.
Okay.
Helpful. I appreciate that and then the follow up topic.
Yeah.
Our equipment.
Health care.
You know, it's not a metric you report, but we can do our own math I calculate a book to Bill if you will.
For you for for health care equipment at it it was like 1.0 last quarter it was sub.
0.9 this quarter.
But my question is on like the the the fresh order environment and I want to set it up this way like you have a big backlog, you're you have been working real hard to convert the backlog in <unk>.
And we're seeing conversion rates tick up and.
It's pretty clear.
I I I wonder about like your willingness to refill the backlog as fast like is there an element where you just you know.
Do you need to bid for new businesses is as much at the moment right now as you otherwise would because of the backlog and that's a dynamic. So I'm curious there and then just just broadly on hospital capital spending if you will as we move into calendar 'twenty for like similar seeing stresses.
Strains no impact and any thoughts on this would be great. Thanks.
Yeah, just a couple of F. A lot just a couple of comments and I would say as you know.
Our orders remain strong and I mean, there's so much activity out in the field in terms of our portfolio right now and I guess what are the positive signs I saw was the significant increase in our replacement business in the last quarter or so versus the prior few periods and that tells me that a our customers have confidence we can and our field also has confidence we can deliver in a.
A short period of time with normal lead times.
B they are willing to spend money on a lot of pent up.
Maintenance Capex that our hospital systems have and I've talked about this before and that is that although the health care providers are not necessarily killing it financially right now they definitely are on a path to profitability and the many of them are in a good cash flow situation, whereas there was a lot more concern a year ago.
And the reality of it is as well is that our our capital equipment is not they're not luxury products. These are these are capacity enablers you can't do procedures without lights and tables, you can't do procedures without adequate capacity in the stereo processing Department.
And that's that's really what we do it's not all that sexy, but it's a requirement.
Thank you.
Yeah.
And our next question comes from Mike Matson from Needham <unk> Company. Please go ahead with your question.
Yeah. Thanks, So I guess I'll start with the dental business you know it was down again, it looks like you're starting to lap some of the declines.
We've been seeing so.
Is that I guess just whats.
The outlook there or is it just really boil down to kind of the economic headwinds or something else maybe.
Yeah, I mean short term, we expect it to be about flat this fiscal year.
And and we would attribute that entirely to the economic downturn.
Downturn and the ability of people to spend cash right now on an elective type dental type procedures and it is it just generally impacting the entire industry and others have spoken up that on that topic prior to us Im sure in the last couple of weeks you know long term, we think it's a solid mid single digit grower.
But some of these some of these challenges facing discretionary spending in particular in the U S economy, you've got to get sorted out in order for it to get back to those type numbers.
Yeah, Okay and then.
It does look like you're obviously working down the backlog and they are about the health care business, but and what I wanted to ask about hospital staffing with regard to getting the equipment installed I know that that's been an issue in the past at least for some companies as you know.
Have you seen that improving is that okay.
St.
You know ability to.
Book the revenue there.
No we've seen that I mean, there's more coordination today than there used to be maybe in terms of getting stuff received and at the docks and getting.
Getting shipments married up so we can do install but keep in mind, we've got well over 1000 tests in the U S that do this work for US that are full time status employees that are that are ready to go to help shepherd the process to get our stuff into the doors and also get it installed properly.
Okay got it.
And then I know you may have addressed this in my prepared remarks, if I got on a call. It a wait so I just wanted to ask about the gross margin and it didn't look like it was down.
A little bit sequentially.
Uh huh.
You had a nice improvement I guess last quarter sequentially from the fourth quarter, but.
Just any color or commentary there would be helpful.
Yeah, Mike we had mentioned in the prepared remarks that the ear.
Even though margin and gross margin was down 50 basis points.
We did have favorable price, but unfortunately that was more than offset by lower productivity and continued material and labor inflation.
So you know the productivity as we are moving stuff through the facility. We are not as efficient as we typically would be so that that negative productivity is hurting us in the short run.
Yeah got it.
S T volumes declined sequentially I don't know Martin.
Yeah, Okay. Thank you.
Once again, if you would like to ask a question. Please press star and one <unk>.
Our next question comes from Jason Bednar from Piper Sandler. Please go ahead with your question.
Hey, good morning, Thanks for taking my questions here.
Wanted to start on the topic of the day here at DST, but.
But maybe first on the Capex side with I S. T. Just the decision to postpone some of those projects.
Influencing the capex outlook for the for the year I appreciate.
I appreciate you wanting to protect free cash flow, but is there a risk at all here that you're foregoing future growth and a S T.
We just did not adding capacity and should we be thinking about this capex then shifting out of fiscal 'twenty four into 'twenty five in just next year being an above normal year of Capex spend.
Yeah, Jason This is Dan. Thanks. Thank you for the question just to be very clear, we're not delaying these shipments they were delayed just by natural building and just current environment of getting things installed and everything else and permitting processes and everything else. So it's we have not intentionally slowed doesn't any ways they've just naturally slowed.
And yes. The answer is we would expect those now to be would bleed over into next fiscal year from a capex perspective.
We haven't pulled any projects specifically yeah.
Okay, Dan you're talking about the capex spend not the equipment bigger recognizing this revenue just to be clear.
Correct, Yeah, so I'm talking about Capex spend.
Okay. Okay. So it was like $65 million.
Spend that's shifting out of this year into next year.
The bulk of that is ASP, it's not 100% of ASP, but the bulk of that $65 million is directly related to the a S. D segment.
Got it okay alright, thank you.
And then.
We've had some questions here on backlog it sits down $100 million from peak levels I know, we're running well above normal for a long period of time.
What do you see as the baseline where do you think backlog settles in a normal environment, how much more backlog work down do you think we need to see.
And we think we think normal somewhere around $3 50, but we're happy to keep it higher if we keep pulling in orders. It was artificially high in the past because of our ability to manufacture and deliver you know and as we've sort of solve those issues from a supply chain perspective.
It's now it really coming down and it looks at an accelerated pace.
Although I wouldn't I would say that our lead times continue to be longer than we would like them to be yes.
Okay, Alright, Thanks, and then last question for me.
I don't think I heard it but yeah I did I apologize.
Are you able to bifurcate, what you're seeing with your U S. A S. T services business in contrast that against what you're seeing in Europe, and how much of a growth rate delta or you've seen across those two markets.
It seems like the opportunity for improvement here is more dependent on the European market, improving so just wondering what kind of visibility you have on procedures in that geography recovering and if youre seeing anything or hearing anything from your partners that it would be in an encouraging leading indicator.
We do we do look at it and we have a lot of data points, obviously being in the hospitals and also dealing with directly with all of our customers and their insights of what's going on in the market and Theres a lot of public information from NHS and you know the other public health commissions in Europe.
You know what I would say is it's it's gotta get better and and even at the procedure rates don't improve at some point the inventory burn down crosses over and we get back to normal.
Talking from our customer perspective, and you know everybody got really bloated on inventory over the last couple of years and everybody now is trying to bring it down and we've heard we've heard some customers say as much as 40 or 50%.
And that and that takes considerable time like I said, we've crossed over that line in the U S. And we believe it will we will get to that point in the coming weeks or months.
Why not quarters I would say.
Relative to the European Destocking as it relates to med Tech and the other driver we talked about is as we get into the back half of the year the comps on bio processing.
The single use disposables.
Come a little a little easier against us that's been a real headwind for the first two quarters here.
Okay alright, thank you.
And ladies and gentlemen at this point in showing no additional questions I'd like to turn the floor back over to the management team for any closing remarks.
Thank you everybody for taking the time to join us and I have a busy week and we do look forward to seeing many of you out on the road.
The next few weeks at several conferences.
Yeah.
Ladies and gentlemen, with that we'll conclude today's conference call and presentation. Thank you for joining you may now disconnect your lines.