STERIS plc

Good morning and welcome to the Staris PLC first quarter 2020 conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touch-tone phone. To try a question, please press star then two. Please note, this event is being recorded. I now would like to turn the conference over to your host today, Julie Winter, Senior Director of Investor Relations. Please go ahead, ma'am.

Thank you, Keith, and good morning, everyone. As usual on today's call, we have Walt Rosebra, our President and CEO, and Mike Tokich, our Senior Vice President and CFO. 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 express written consent of Staris is strictly prohibited. Some of the statements made during this review are or may be considered forward-looking statements. Many important factors could also cause actual results to differ materially from those in the forward-looking statements, including without limitation those risk factors described in Staris' 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. DERIS's 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, segment operating income, constant currency organic revenue growth, and free cash flow will be used. Additional information regarding these measures, including definitions, is available in today's release, 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. With those questions, I will hand the call over to Mike.

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 first quarter performance. For the quarter, constant currency organic revenue growth was 10%, driven by volume and 120 basis points of price. We continue to experience strong underlying growth from our customers and success with new products. Gross margin for the quarter increased 190 basis points to 44.2%, and was favorably impacted by productivity, price, mix, and currency, somewhat offset by higher labor and material costs. EBIT margin for the quarter was 19.5% of revenue, an increase of 160 basis points from the first quarter last year, despite an increase in SG&A expenses, mostly relating to higher incentive compensation given the strength of the quarter. The adjusted effective tax rate in the quarter was 16.2 percent, somewhat lower than we had anticipated due to favorable discrete items, primarily the benefit related to stock compensation expenses. Net income in the quarter grew 23 percent to $105 million, and its earnings increased to $1.23 per diluted share, benefiting from revenue growth, margin expansion, and a lower tax rate. In terms of the balance sheet, We ended June with $238.1 million of cash and $1.2 billion in total debt. During the first quarter, capital expenditures totaled $49.8 million, while depreciation and amortization was $47.1 million. Free cash flow for the first three months declined, as anticipated, to $59.6 million due to the increased capital spending. With that, I will turn the call over to Walt for his remarks.

Thanks, Michael, and good morning, everyone. As you've already heard from Mike, we started fiscal 2020 stronger than expected, with growth meeting or exceeding our expectations in all four segments. The additional volume and the lower effective tax rate drove earnings above our expectations for the quarter. Based on our performance in the first quarter and revised expectations for the rest of the fiscal year, we are now updating our full-year outlook. Starting with revenue, we now expect constant currency organic revenue growth of 6% to 7% for fiscal 2020, up 100 basis points from our original 5% to 6% range. The updated revenue forecast suggests that the outperformance in the first quarter holds for the year and that we will experience somewhat higher volumes than we originally planned over the remaining course of the year. The two segments of our business that are driving the increased volume growth for the year versus our original plan are healthcare products and AST. Healthcare products is seeing improved demand for both consumables and capital equipment. Our new products have helped grow consumable sales in sterility assurance, instrument cleaning chemistries, and vPro consumables. On the capital equipment side, we have a strong backlog of capital equipment orders and a healthy pipeline going forward. When our capital equipment grows significantly, we can run into capacity constraints in our shared manufacturing facilities in any given period. Our revenue forecast recognizes our efforts to run our plants at normalized run rates throughout the year, which creates some risk for potential timing issues in capital equipment shipments at quarter ends and year ends. The AST segment continues to deliver strong growth as increased demand from our core medical device customers continues. and we feel the capacity of the expansions we have made in past years. This encourages us about our significant expansion plans for AST that we have previously reported. With the additional volume growth for the total company, we are increasingly comfortable with approximately 75 basis point improvement in EBIT margin percentage. We also anticipate that our effective tax rate for FY20 will be at the low end of our original guidance of 19 to 20 percent. With all these factors considered, we now anticipate adjusted earnings per diluted share to be in the range of $5.38 to $5.53, up 10 cents from our original outlook. While our first quarter exceeded consensus by 12 cents, it did not beat our internal plan by that much. As a result, we continue to expect earnings in our revised forecast to be weighted about 45% in the first half and 55% in the second half. The rest of our outlook is unchanged, as we continue to expect about $280 million in capital spending to fuel future organic growth in our businesses and $300 million in free cash flow for the year. Our capital spending has started the year a bit light, as Mike has said, but we expect it to ramp up over the next three quarters as our projects move forward. On a completely different note, as you likely saw in our proxy, we had several board members retire as of our annual meeting. Loyal Wilson had the foresight to be the initial primary investor in Steris over 30 years ago, has served on our board ever since, and has made innumerable contributions over his tenure. Dr. Michael Wood has been a board member for 15 years and has brought a unique perspective as a surgeon and former CEO of the Mayo Clinic. and Sir Duncan Nicol, former head of the NHS in the UK, joined our board several years ago as the result of our combination with Synergy Health, where he was chairman and a long-standing board member. All three of these individuals have made significant contributions to our company over many years. We thank them for their service and wish them the very best. In closing, we started this year strong and continue to expect another year of record performance in FY20. We believe the short-term and the long-term future for Steris is bright, and we appreciate your ongoing support. We are now pleased to take any questions you may have. Julie, can you start Q&A, please?

Thank you, Walt and Mike, for your comments. Keith, would you please give the instructions, and we'll get started on Q&A.

Yes, certainly. We will now begin the question-and-answer session. To ask a question, you may press star then 1 on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To draw your question, please press star then two. At this time, we will pause momentarily to assemble the roster. And the first question comes from Matthew Michon with KeyBank.

Great, and thank you for taking the questions and an outstanding quarter.

Thanks, Matt.

Walt, Mike, can you guys start off with AST and... maybe kind of help explain the increased demand you're seeing and whether or not it's near-term transitory due to a competitor issue, or is this just large-scale market share gains you're seeing over a multi-year period of time?

You know, Matt, we have been very strong in AST now for several quarters, stronger than our expectation, frankly. There's been some I think we reported last time some modest increase probably due to brexit in Europe there's been some modest increase due to the Chicago closing that you refer to And then there's been just good underlying generic increases We've talked about this before you know we continue to put capacity in places where our medical device customers are expanding and we haven't seen a The OEMs who are making these devices, generally speaking, haven't been building capacity for that growth. So, by definition, they're outsourcing more, and we have had the good fortune of picking up probably more than our fair share of that growth due to having our plants in the right places. And that's why we have continued expanding kind of on the come, if you will, for the next 10 years, and we will continue to do that. We're comfortable that we're growing a bit faster than the market, but I don't think it's radically faster, and it's not due to any particular big swing of a customer A to customer B or someone from a customer moving to us. We call this churn. Our net churn has been roughly – constant for quite a while. We have picked up positively for quite a while, but it's not out of range. So this is, for lack of better terms, true growth and picking up the growth of the device customers. And we are obviously getting a little bit better than our fair share.

Okay, outstanding. And then could you also give us a sense of the momentum you're seeing right now in your U.S. ORC business?

You know, Matt, this conversation is not dissimilar from what we've been saying, and that is that business is continuing to grow. It's growing nicely, faster than our average growth, and it will grow in a little bit lumpy terms probably in the short run, but I can tell you that the pipeline of people who are interested in doing things continues to grow, and we feel very good about the growth prospects going forward.

All right, and then lastly, international versus U.S. There have been some other companies that have indicated there's been some international cap equipment delays. Any trends you're seeing differently there versus here?

Yeah, you know, we've seen Europe is kind of flat, so if you look at that relative to the U.S., no question that it has not grown as the U.S. has the U.S., has been hot now for a while and continues hot in our view. Latin America for us has kind of picked up. Since the relative volume there is small, it's hard to tell if we have just picked up some orders or if the market is a little stronger, but we feel much better about Latin America. Asia Pacific has also done nicely, so we're comfortable there. But kind of the weak spot, if you will, for growth has been in Europe the last little bit, and I think that's consistent with what other people have reported.

Thank you very much, Walt.

Thank you. I'm sorry. I'm sorry. Thank you. The next question comes from Chris Cooley with us, Stevens.

Good morning. I appreciate you taking the questions. Walt, I'm trying to think when the last time it's been that I've seen you actually raise guidance on the first fiscal quarter, and it's been some time.

I suspect, Chris, you haven't found one.

That's right, but my memory starts to lose me now at this age. So I guess two quick questions for me. One, when we looked at the quarter, obviously it was very, very strong. But if we did want to need anything, it's the rate of growth in the backlog did decelerate both within healthcare capital and as expected within the life science space. Could you just maybe remind us what you're seeing there? While I think the life science segment makes a lot of sense and is expected, the deceleration to basically 6% growth in the backlog year over year, a little bit lower than maybe I would have anticipated. So just maybe talk to us a little bit about what you're seeing in the capital environment, healthcare capital environment in the short run, and I have a quick follow-up.

Yeah, Chris, we're not seeing any deceleration of pipeline or order pipeline coming in. In fact, if anything, it would be the opposite. Backlog is a relatively small piece of orders, and it's orders minus shipments, so we shipped a bit more in this quarter than you might have expected, and the backlog fell a little bit, but in terms of You know, order rates, pipeline, we're not seeing any decline. So this is a temporal change, which often happens in capital in any given quarter. As you know, we've grown backlog a lot in the last 12 months, and so if it drops off a little bit, it doesn't concern us. There's some point in which, in fact, you know, we have two types of orders, some that ship in 12 to 18 months, and some that ship in, and usually more like six to nine in healthcare, and 12 to 24 in my science. But there are some points, if you have a lot of your backlog that is ASAP-type backlog, having too much actually is a problem. So, you know, when we have a bunch of ASAP orders from customers, we try to get them out as quickly as we can. So this does not concern us at all, and it does not reflect any concern in our view of orders coming in or pipeline for orders.

And, Chris, this is Mike. The other number that – well, you are correct in the 6%, but if you look at sequentially, we were up – $33 million or 21%. So, again, it has a lot to do with timing and fluctuations. And we were up 7% growth in capital equipment for the quarter, which is a little bit higher than we typically see anyhow. So, it's all about the timing. Again, to Walt's point, I don't think there's any concern on our end.

But, I mean, I don't disagree, Chris. If you see shrinking backlog, then that would give you pause. It's just that backlog is such a small piece of your total shipments that it's the order rates coming in that we're more interested in, and that still looks strong.

I appreciate the additional color. It's what I thought. Just lastly then for me, when you look at AST, I believe you've got a new high watermark for operating margin in the quarter looking back here historically, which is really impressive. Talk to us maybe about where you are in terms of existing capacity utilization, maybe how the mix has shifted across sterilization techniques, basically just trying to get a little bit better feel for is this, can we improve upon this new high water mark as we go through the fiscal year, or is this kind of the new normal as we model that business? Thanks so much.

Sure, Chris. Great question. And, you know, in terms of that, our plants, when we grow faster than we expect, and as we have said, we're building plants, so our plants are getting pretty full And it's more a function of our plants being very nicely utilized right now on a percentage run basis than kind of any other factor. So, you know, we will see temporal fluctuations in those numbers, and right now we're running pretty hot. I wouldn't bet my life on 44% the rest of the time. But, I mean, obviously we've been, you know, in the high 30s and low 40s for a while. I think those numbers are reasonable numbers to be thinking about.

Congratulations on the quarter.

Thanks, Chris.

Thank you. And the next question comes from Jason Rogers with Great Lakes Review.

Yes. Just looking at your improved outlook on the healthcare product side, how much would you say of that is due to the new product introductions? Is there anything on the consumable or the equipment side that you would consider a needle mover there?

Yeah, you know, on that, you know, I've forgotten exactly the number, but we have something in the order of 20, 30 new products that we introduced last year, which are really what's filling the pipeline for this year. And we have 20 or 30 new products that we're going to introduce this year. And I might even be a little on the light side on the healthcare product side. So it's not any one silver bullet. It's just a lot of new products that are picking up steam. I mentioned the ones where We've seen some kind of significant growth. I mentioned that in the text. The Australia Assurance products are growing quite nicely for us right now. We have a number of new products in that space. You know, vPro is driven not by new consumables, but by new products, new capital products as we place those new capital products. And we have just a completely new line of vPro now, and those new capital products do drive the consumables or allow the consumables to grow. And then our ICC business, again, we have multiple new products in the instrument cleaning chemistries, and those are just continuing to take hold. We think we have the best line in ICC now. by a significant margin. So they continue to grow. So it's not any one product. And there's a series of also sterilizers and washers, particularly for Europe. We're not seeing any one product be a dominant force here. It's just multiple products. And the combination of them, washers, sterilizers, and the things that go with them, ORI and tables and lights and the things that go with them, it's not so much a single product. It's the family of products working together that I think is the driver.

All right. And any change in expectations for the impact on tariffs? I don't think it's that material, but I just wanted to check on that.

Good check. Our best estimate at this time of the newest round of China tariffs is something on the order of $1 million a year. So although we don't like seeing $1 million a year disappear, it's well within the guidance range that we've laid out.

All right. Thank you.

Thank you. And the next question comes from Mitchell Ramgopal with Sedoti.

Yes, hi, good morning. Just a couple of questions. First, on the restructuring plan announced back in December, I was just wondering if you're still holding to about the $12 million of cost savings with half this year and half next year in terms of this?

Yeah, Mitchell, we are on target. That $6 million will be mostly in the back half of the year, which is reflected in our outlook for the savings, and we are definitely tracking on target. Good question.

Okay, thanks. And, Mike, it looks like you might have done a tuck-in acquisition this quarter. I was just wondering if you had any additional color on that.

Yeah, we did a small acquisition in the middle of the quarter. It was a systems acquisition in our healthcare space, specifically in our IPT, infection prevention technology space, that will generate somewhere in the neighborhood of around $10 million of revenue this year.

Okay, thanks. That was great. And then just coming back on the life sciences business, I know that has obviously been a little lumpy in the past, but if you look at the last couple of years, it's actually been holding up pretty well. I was just wondering if you think, you know, going forward, we should continue to kind of see these numbers in terms of where the backlog is.

Yeah, you know, as we've said, we had this huge run-up of business probably three years ago now. It's hard to remember, but where we were growing 20%, 25% a year for 18 months or 24 months or so. And then we've sort of leveled off at that level. We're very comfortable at that level. Our backlog has remained roughly in the $60 million range. And when we're in that range of backlog, we feel we can do these numbers. So on the capital equipment side in life science, we're pretty comfortable. We're seeing growth, but it's modest growth, more in line with low single-digit kind of growth, not atypical of capital equipment. But it is lumpy. This last quarter, it's 35%, 40% up. And the previous quarter, it was golf a little bit. So that's kind of the way that business works. Relatively small amounts of business that comes in large sizes. Those machines can be a million and a half dollars apiece. So you get a couple of those together, and you have a really good quarter. If a couple of them slip into the next quarter, you have a weak quarter. But we're pretty comfortable of sustaining that level at this point in time, and our visibility out in the future looks that way as well. So we're pretty comfortable there. The considerable side is continuing to grow very nicely, and we anticipate that continuing.

Okay, thanks. That's very helpful, and congrats again on a great quarter.

Thank you. Thank you. And once again, please press star, then 1 if you would like to ask a question. And the next question comes from Larry Klitsch with Raymond James.

Good morning, everyone. So two questions. Walt, look, I appreciate the strong start to the year and the increase in the organic constant currency guidance to that 6% to 7% range. But given that you just came off a 10% organic quarter, How do we reconcile the implied deceleration as you move through the year?

Larry, we just had a hot quarter, and I don't think we would characterize our entire business growing 10% a year going forward. Obviously, the math suggests a slowdown. I haven't done the actual numbers myself. I'm guessing in the five to six range, something like that, to get to that, which is well within our normal range. We had a hot quarter. We're having a strong year. We anticipate continuing to have a strong year. But we're not ready to say we're 10% growth at infinity. So I think that's pretty much the reconciliation.

Okay, perfect. And then just given that the dollar has generally continued to strengthen, can you remind us again just how we should be thinking about some of the impacts from the currencies, whether it be the Mexican peso or the pound?

Yeah, Larry, this is Mike. So in general, what we tend to like is a strong euro and a strong pound. And then on the opposite side, we tend to like a weak peso and a weak Canadian dollar. And the reasons for that is on the Canadian side and the Mexican side, we have manufacturing So the lower the cost, the better for us. And then on the euro and the pound, we have a sales channel, so we get more benefit by having those currencies, the pound and the euro, at a much higher exchange rate than the dollar.

And the euro and the pound are largely service businesses for us. It's more heavily weighted to service as opposed to product. So the revenue and cost travel together, but the margin component shrinks if it's if those currencies shrink. But I would say, too, Larry, all people who export, which we do export a fair amount, and we export a fair amount from the United States, not just from Canada and Mexico and France and Finland where we have products and the U.K. So we export from all those places to a lot of other countries. And so pressure on those, as those currencies rise, it puts pressure on us. But we're getting to where we're fairly neutral to those kind of questions because it's rare for the five or six currencies I reeled off where we have manufacturing plants to all be moving in the same direction against everybody else. So we're more naturally hedged both on a profit basis and on a overall can we sell things at a against tougher currencies. We're more hedged than we've ever been.

Okay, perfect. And just lastly on that, can you just remind me, I just don't have it off the top of my head, were there any changes made to the FX outlook for the year on this quarter?

We did increase the negative impact for revenue to $10 million, and we still believe EBIT is neutral. So no impact on the bottom line, but increase on the negative side on the top line.

Okay, perfect. Thanks, Mike. Thanks, Walt.

You're welcome. Thanks, Larry.

Thank you. And the next question comes from Dave Tugavely with JMP Securities.

Thank you, and congrats. Walt, just one sort of high-level question here, and we've kind of talked around this a bit, but in the past, noting that every time there's a surgical procedure in a hospital, there's a revenue opportunity for steroids. I'd love to get your thoughts on that. Hospital volumes, procedure volumes, and what you think is sort of happening, you know, if we look at this quarter, really across segments in the medical device world, there's a lot of strength. And I don't know, you know, pointing to any specifics, I'm curious if you're seeing anything that's maybe driving an increase in surgical procedures or, you know, operations.

Yeah, well, no, you're exactly right. We clearly are seeing strength. in medical devices in terms of volumes. Every hospital that I've talked to recently tells me their OR is busy and so we're seeing those facilities busy. Now you have to separate, you asked about hospitals, you have to separate inpatient care from inpatient surgeries from outpatient surgeries. For our purposes, we don't really care if the surgery is inpatient or outpatient. And by the way, I use surgery in the broadest sense. It can be any number of procedures, like endoscopic procedures, where our U.S. endoscopy business works really well if they're doing those procedures. So procedures in hospitals and or ambulatory surgery centers or GI centers or other procedural centers, in our view, it has clearly been strong. We've said before for the long term, if you look at the high level, for the long term we have the baby boom in North America running through it and much of Western Europe. And that baby boom wants to have new hips and new shoulders and a scoped knee and multiple other issues. And as fast as ambulatory surgery is growing, which it is, and ambulatory surgery in the U.S. at least is the fastest growing area for our business, as fast as it's growing, it's also getting more complexity and they need to do have real sterilization capabilities in ambulatory surgery centers and other GI centers. And by the same token, there are more and more complex surgeries being done in the acute settings. And so even though it looks like, oh gee, we only did five surgeries, but if two of them are double transplants, that's very different than doing five-scope knees. So I think both the complexity of surgeries in acute care continues to rise, In ambulatory surgery, we're seeing faster growth as the less intensive procedures are moving more and more in the ambulatory setting where patients want them to be. And we have this push of the baby boom coming through who is going to require more and more in all of the Western world or the industrialized world. And then the non-industrialized world, as their GDP per capita rises, more and more people can afford this kind of health care. So we think the long-term outlook for the rate of procedures is quite good, which is why we've invested in that space.

Thank you for all the detail.

Thank you. And next is a follow-up from Matthew Michon with KeyBank.

Hey, great. This is definitely a follow-up to David's question. I guess, how has your value proposition to the hospital system especially with the rise in share of the ASEs, changed over the last couple of years?

Well, you know, Matt, I would say I don't think it's radically changed in a couple of years, but what we have done, as you have seen, is we bring more and more products and services around this procedural space. And so we are stronger today due to the family of products and services. You know, bringing in IMS, so we can help them with their surgical instruments, bringing in the ORC concepts, bringing in the mobile units that were, if they're out of capacity, we can help them out in addition to all the new products and services that we brought in then to the healthcare products. We just are a much stronger entity and more able to help them in many different ways in the procedural areas. But I wouldn't call it a radical change in the last two years. But if you look at the last dozen years, you know, we're a very different entity when we're facing the hospital procedural errors than we were 10 years ago, let's say.

Okay. And, like, last quarter you talked a little bit about some, what's it called, stocking ahead of Brexit, and you talked about as well as a shift in manufacturing in life sciences, you know, positively impacting sales by about 5 to 10 million. And then you also talked about a headwind from your larger restructuring that you're absorbing on top of that. Can you just talk a little bit maybe about the timing of those and when you expect to see those shifts through 2020?

Yeah, Matt, great question. And I'll kind of try to walk through the two or three items that you mentioned, actually. First of all, vis-a-vis Brexit and Well, to meet the Brexit, you know, we said at the time we were pretty sure there was about $5 million pulled forward, and we had no idea how much else it might be. And so we were guessing in the $5 to $10 million range. You know, we still don't really know because, you know, we don't have visibility to all that space. But the fact that the quarter stayed very strong suggests that it wasn't $10 million. that it was probably closer to the five number that we were well aware of, plus or minus a million or two. So we're feeling a bit more comfortable that it was the known numbers plus a little as opposed to the known numbers times two or three or four. And so that's point one. Point two, given the fact Brexit is not adjudicated, we do think whatever that number is, some point in the future, and I suspect it would be after and maybe well after the dust settles on how the UK is going to Brexit or not. But I wouldn't see, I think, just speaking from ourselves, the buildup we've made, we're not planning to pull it down and then build it back up again. We're just letting it sit there until they sort out Brexit. I think that's the most logical thing. So You tell me when and how they're going to exit, and I'll give you the answer. But I think we're more comfortable within the few million dollar range. In terms of our plant closure, we saw exactly what we expected. There was order pull forward, and those orders fell off in the quarter, so we're over that. That's done. That's part of the reason we feel comfortable, even more comfortable with our forecast, because we absorbed that without, in fact, not only without a loss, but that still was at our plan. So we absorbed that one. And in terms of the product closures, that will still be out there over probably the next 12 to 15 months. But it's relatively small numbers and will be spread over a large number of months. So I don't think you'll notice it. I think I hit all the topics there, Matt.

Yeah, I think you got them all.

Thank you. And as there are no more questions, I would like to return the floor to Julie Winter for any closing comments.

Thank you, Keith, and thank you, everyone, for joining us this morning and for your continued support of Staris. Have a great day.

Thank you. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines.