STERIS plc

Good morning, everyone, and welcome to the Staris PLC third quarter FY 2021 conference call. All participants will be in a listen-only mode. Should you need assistance, please know 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 and then one using a touch-tone telephone. To withdraw your questions, you may press star and two. Please also note today's event is being recorded. And at this time, I'd like to turn the conference call over to Julie Winner, Investor Relations. Ma'am, please go ahead.

Thank you, Jamie. Good morning, everyone. As usual, on today's call, we have Walt Rosebra, our President and CEO, Mike Tokitz, our Senior Vice President and CFO, and Dan Crestio, our Chief Operating Officer. I do have a few words of caution before we open for comments from management. 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 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 on today's 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. Those cautions, 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 third quarter performance. For the quarter, cost of currency organic revenue increased 1.4%, driven by 130 basis points of favorable price and 10 basis points of organic volume growth. Gross margin for the quarter was up 110 basis points to 44.2% and benefited from productivity, price, and acquisitions. EBIT margin for the quarter was 23.6% of revenue, an increase of 250 basis points from the third quarter last year, due primarily to higher gross margin attainment and lower operating expenses for travel, sales and marketing, and compensation due in part from the business disruption from COVID-19. Our adjusted effective tax rate in the quarter was 18.4%, somewhat lower than anticipated due to favorable discrete items. That income in the quarter grew 20% to $149.2 million, and earnings increased to $1.73 per diluted share as compared to $1.45 per diluted share in the prior year. Our balance sheet is a continued source of strength for the company. Our leverage ratio at the end of the third quarter is once again below two times as we continue to pay down debt post the key surgical acquisition. Considering our cash position of $253 million, access to available credit lines, and a low leverage ratio, we are well positioned from a liquidity standpoint. During the third quarter, capital expenditures totaled $53.8 million, while depreciation and amortization was $56.8 million. Free cash flow for the first nine months was strong at $337.7 million, an increase of almost $100 million over the same period last year, primarily due to improvement in net income and working capital, somewhat offset by higher capital expenditures. With that, I will now turn the call over to Walt for his remarks.

Thanks, Mike, and good morning, everyone. It's a pleasure to be with you to discuss our third quarter results, which once again demonstrate the resilience of our business and the great work of our associates to serve the needs of our customers. Once again, we want to acknowledge the caregivers around the globe who are on the front lines of this pandemic and doing such a tremendous job. Looking back at the first three quarters of this fiscal year, the sequential improvement of our business is impressive. While we continue to experience the challenges of a global pandemic, the worst impact on our business appears to be in the rearview mirror. Despite significant numbers of new COVID-19 cases and some hospitals around the globe close to or at capacity, procedures continue to occur. Our most significant concern, healthcare capital equipment, achieved a critical milestone, showing three straight quarters of sequential improvement and ending the third quarter with an all-time record order month. This resulted in near record backlog, which is greater than that before the pandemic at the end of Q3 last year. Even with pockets of slowdowns in procedures due to COVID-19 uptick, we are quite pleased with our position at this point of our fiscal year. Constant currency organic revenue grew 1% in our third quarter, driven by double digit growth in AST, which was offset by flat to slightly down revenue in life sciences and healthcare on a constant currency organic basis. Our strong growth in AST continues to be favorably impacted by demand for COVID related single use products, such as PPE and COVID testing materials, as well as components used in vaccine manufacturing and packaging. The business has also seen steady demand from its core medical device customers. Life science revenue was flat in the quarter, with mid single-digit growth in consumables and services offset by a decline in capital equipment shipments. On the consumable side, we have been anticipating a return to more normalized growth for some time. It appears our customers are destocking the excess inventory that was built up over the last three quarters. With COVID vaccines now in production, we expect to see sustained high demand for our consumables offering, but not at the extraordinary growth rate of recent quarters when our pharma customers built inventory due to surety supply concerns for vaccine production. And as we have commented frequently over the years, capital equipment shipments in life science can be lumpy. The decline in Q3 was strictly a matter of timing, as capital equipment orders were strong in the quarter, reflected in our life sciences record capital equipment order backlog. Healthcare benefited from the addition of Key Surgical during the quarter, which added about $15 million to healthcare consumable revenue. While it's still early days, we are quite pleased with our integration efforts and what we're seeing so far in that business. We continue to have high expectations for Key Surgical going forward. As I mentioned earlier, while the shipments for healthcare capital equipment declined year over year for the quarter, we did see sequential improvement from Q2 to Q3, and backlog ended above last year's levels. We are cautiously optimistic about our fourth quarter and start of our new fiscal year regarding healthcare capital equipment, as the risks appear to have declined throughout this fiscal year. Our profit overall has exceeded our expectations as we continue to see the benefit of continued efficiency gains along with lower operating expenses. The operating expense reduction is largely due to travel disruptions from the pandemic. As we've said all year, we do expect some of those expenses to phase back in as travel resumes, returning our operating expenses to more normal levels. We are committed, however, to evaluating opportunities to permanently reduce expenses as we have learned that some things can be accomplished virtually. Adjusted earnings for the quarter, as Mike mentioned, were $1.73 per diluted share, or growth of 19%, as we benefited from higher gross margins, reduced operating expenses, and a slightly lower than anticipated tax rate. With just two months remaining in our fiscal year, we like where we stand today and the long-term positioning of our global portfolio. Our thoughts on the full fiscal year have not changed materially from what we discussed last quarter. Constant currency organic revenue, excluding acquisitions, should be about flat for the fiscal year. That's impressive performance in this environment. But it is safe to say that we all look forward to getting back to normal and delivering the revenue growth we know we are capable of in the longer term. Once again, I would like to thank Steris people for their commitment to our customers, those healthcare professionals who continue to do a simply miraculous job on the front lines of this pandemic. We also welcome the people of Key Surgical to our team. And we're working through the process to complete the acquisition of Cantel Medical and look forward to welcoming the Cantel people to the Steris family as well. Now, before we open the Q&A, I want to comment on our announcement that I will be stepping down as CEO at the end of July. The board and I have been working on my succession for years, and while we have other capable candidates, Dan Carestio, our current chief operating officer, is our unanimous choice. Dan, the board and I have been working to prepare him for this transition. And as the announcement said, I will be available through July of 2023 as an advisor to management and the board. As you all know, I hold a significant amount of Starus stock and options and continue to be highly vested in our long-term success, both personally and financially. When I came to Starus a little over 13 years ago, the preponderance of investors and analysts advised me to exit the life science and AST business due to their moribund performance. I worked with the executives of those groups to determine whether or not that was the way to go. The answer is now abundantly clear, and we have Dan and his teams to thank for the improvements in those segments. Dan's early executive leadership role was running sales and marketing for the AST group. He developed and implemented the strategy to improve that business. A few years later, I asked him to take on life science as a general manager while maintaining the sales and marketing leadership for AST. He worked with that team and led the improvement in life sciences while continuing the success at AST. He then successfully integrated Synergy Health AST business as General Manager of AST and Life Sciences. Dan took on the leadership of our healthcare IPT business several years ago, making him responsible then for all sterilization and disinfection products across the Steris portfolio. And finally, he became responsible for all of our operations as Chief Operating Officer in 2018. Steris' performance the past 13 years for which I have happily been able to take credit, are significantly the result of the work done by Dan and his management teams. I am extremely confident that he is the right person to lead Steris into the future. To add to that confidence, I could relate a similar story about many additional members of our senior management team, especially including our CFO, our general counsel, and the leaders of the commercial operations and business units of Steris. Almost all of those leaders have been with us or companies we've acquired for over 15 years and have stepped up and made significant improvements in their operations while taking on increasing responsibility as we have grown. They've done great work that is individually and collectively added to the success of our company. The median tenure of our 27 members of our senior management team is over 15 years, longer than I've been with the company. The median age is 53, so Mo should be here for a good long time. That talented senior management team, along with the 13,000 people of Steris, are the bedrock of our past success and why Steris' future is bright. And Dan and I both know it. I'm looking forward to having more time to spend with my family beginning this fall. I am blessed with a wife of over 40 years I meant to say a wonderful wife of over 40 years and have two fantastic adult children and their spouses who have given us nine young grandchildren. But I'm not stepping down until the end of July and will be fully engaged as CEO until that time. After that, I will be available to our management team and the board of directors for an additional two years. We believe that Starus is stronger and better positioned than ever. The Staris team stands ready to capture additional opportunities, and we continue to be confident that the future of Staris is bright. With that, I will turn the call over to Julie for Q&A.

Thank you, Mike and Walt, for your comments. Jamie, if you would please give the instructions and we could get started on Q&A.

Ladies and gentlemen, at this time we'll begin the question and answer session. To ask a question, once again, you may press star and then 1 using a touch-tone telephone. To withdraw your questions, you may press star and 2. If you are using a speakerphone, we do ask that you please pick up your handsets before pressing the keys to ensure the best sound quality. With that in mind, once again, it is star and then 1 to ask a question. Our first question today comes from Dave Dracali from JMP Securities. Please go ahead with your question.

Great, thanks. So, Walt, I just want to get this timeline straight here. So you do a bunch of big strategic and accretive deals, but put a feather in your cap and then you step down and leave it to Mike and Dan to make it all work. I understand your explanation, but I'd love to just say what gives? How do you do that?

You know, a great question. In my experience, there's always something going on, and usually something big going on in the life of companies. Whether it's an opportunity, an acquisition, a problem, a crisis, there's always something going on. So the question really is, what's the perfect time for a transition? And the perfect time, in my opinion, for a transition is just before a successful CEO is ready to go. and just after the incumbent CEO is ready to take over. That's the perfect time for a change, and that's where we are right now.

Thank you for that. I know you'll be involved. We'll certainly miss you being as actively engaged. I guess just as a quick follow-up, you mentioned Key Surgical. I think you said $15 million. I was just curious if you had any color on where that stood maybe versus what you thought or if there's any positive or negative surprises so far Thanks a lot.

We're generally on track with what we thought with Key Surgical. You know, the time we did the transaction, we're happy to get it done in November, but that's right before the Thanksgiving holidays and the Christmas holidays. So, you know, actually, I think we said we'd do about $15 million, and we beat it by a bit. So we're pretty pleased there.

Thank you. Our next question comes from Larry Cush from Raymond James. Please go ahead with your question.

Thanks. Good morning, everyone. And Walt, congratulations here on what has obviously been a very successful career in building a lot of shareholder value for investors at Steris and certainly wish you well. But I know we'll get a chance to speak again here before the time's out. I guess I wanted to just pick up on a couple of points on the succession and then add a couple of quick sort of maintenance questions. But first, Walt, you sort of talked about what you want to do with your time, but why is now the right time for you to be leaving? And in particular, because you indicated that you'd be in a sort of consulting role here for you know, until July of 2023. And then the second part of that question, I'd really love to hear from Dan, because I think one of the big investor questions will be, you know, gee, this is all happening in front of, you know, the acquisition of Cantel. And so I'd really love to hear from Dan sort of just his thoughts around how he sees approaching integration and, you know, specific thoughts around Key and Cantel specifically.

Sure, Larry. I think I sort of answered the first part of your question already. I do think, again, there's always significant risks, opportunities, whatever, in the life of a company. That's the beauty of it, by the way. That's why CEOs work 50, 70 hours a week is because there's always something going on. There's too much to do all the time. So there's no perfect time, in my view, as it relates to that. Having said that, Uh, the right time is again, uh, uh, well, while I'm still very active, very engaged, uh, love what I'm doing, uh, but see the end. Uh, and when Dan is ready, uh, and he's a little more than ready, he's probably a little anxious to get my ass out of here. But, uh, uh, the short answer is, uh, that, that I think is the key is, is the timing of the, uh, the person leaving and the successor. Now, having said that, um, If anyone who knows me knows that I'm not going to retire today, I'll be in there 60 hours a week until July 29th, and they'll be lucky if they can get me out of here in less than 60 hours a week for the several months after that. I love what I do, love the business. For the last two or three years, for all intents and purposes, I've been giving advice, not driving the business anyway. The people... The senior management team in this business is extraordinary, and they don't need a whole lot of help, in truth. And people like Dan and Mike and the people that work with them are more than capable of doing this work. I mean, truth of the matter is I've hardly been involved in Key because Dan has pretty much taken that on. I've been more involved in Cantel for semi-obvious reasons, and I had historic relationships there. But in terms of implementing the work, I haven't been an implementer for quite a while, so these guys are perfectly capable. I use guys in the both sexes term. By the way, a third of that senior management team is female, so I'm serious about using it in the sex-neutral term, if you will. But these people know what they're doing, and they will do a great job with or without me. Dan, I'll turn the second half to you.

Yeah, thanks, Walt. You know, what I would say is, you know, Larry, since we started the process with Cantel, Mike Tokich and I have led virtually all the diligence efforts in terms of research and working with the leadership of Cantel to get to the synergies we derived. And I know that we're very confident in our leadership team and their involvement in that diligence process as well. And we're ready to execute once we get through the proper regulatory processes, you know, on that deal. In terms of the timing, Ezra, key opportunity here for Steris is to look at the broader integration of Key and Steris and Cantel. There's some real synergies between the three businesses that we believe will play out in the future. And we're well down the path already in terms of integration as it relates to Key Surgical, and we're confident with where we are and the performance of the business. And our management teams have done roughly 50 deals over the last six, seven, eight years, right? This is the I don't want to say it's another day in the office. It's a big deal. There's no doubt. But we did a pretty nice job with these exact teams working on synergy on the integration of that fairly large deal, you know, five or six years ago. So we're confident in our senior leadership's ability to execute on this deal and continue to be successful for Staris.

Okay, terrific. And then just two quick questions here. Just, you know, on the AST margins, you know, again, obviously – Very impressive. And certainly, as I look back over time, I'm not sure that we've hit this sort of margin level in the past. So two questions there. You know, kind of how much of the performance is being driven by opportunities around COVID? And, you know, how should we think about the sustainability or durability of that type of margin within the business? In other words, were there any one-timers? in the quarter to think about? And then the second question, perhaps for Mike, is, you know, the cash flow improvement, again, is notable. You have called out working capital as certainly one of the drivers there. Again, what's the right way to sort of think about room to improve working capital going forward and also how to sort of think about CapEx in a broad sense? Thank you.

Thanks. This is Dan. I can tackle the AST question first, if that's okay. So, you know, we are getting some benefit right now in terms of COVID-related things, like testing kits and swabs and things of that nature clearly are in high demand. And, you know, frankly, everybody with a 3D printer these days is making swabs for test kits right now, and those need to be sterile. You know, in addition, we're seeing increased demand from, you know, vial manufacturers, syringe manufacturers, and and folks involved in supplying components into the manufacturing process for vaccine, as well as significant growth in what we would categorize as bioprocessed sterile disposables that are used in pharmaceutical manufacturing. Those have been on a strong growth uptick for a number of years, but it has been accelerated by the demand in vaccine production. Now, having said that, we're still seeing less than normal demand from our core medical device customers, especially those that operate in the realm of more elective-type procedures, things like orthopedics and spine and things of that nature. So much of the core business has still been a bit suppressed in terms of normal growth rate or normalcy. And we believe a return to normalcy, if you will, that will more than offset the short-term impact of some of the COVID-related benefit. Now, having said that, vaccines aren't going away. I don't anticipate seeing any slowdown in either the bioprocess disposable business or any of the packaging or materials going into vaccines in the future. So we think that will sustain at a pretty high level.

And the margins?

Well, the margins are a function of really utilization and scale of our global footprint. And as the plants right now are pretty full, we're dropping through pretty strongly on the revenue that we have. We've got a number of expansions coming in line, but those are metered out over time where I don't foresee that having any significant impact on the overall margin rate of AST.

And then Larry, I'll take the free cash flow.

So obviously, very strong free cash flow for the first nine months. of the fiscal year, and as I stated earlier, the combination of increases in net income and working capital improvements, specifically when I'm talking working capital improvements, we've seen fantastic efforts across our business in the collections of our outstanding AR, our balances, and actually our DSO has once again been down about two days for the third quarter, and we've continued to see improvements in those collection efforts throughout the whole year. And that's on top of elevated inventory levels, which we continue to maintain surety supply and level load. So if I look at longer term, obviously I don't know if the levels of AR collections will be this good sitting here next year, but obviously the opportunity for us is to reduce the inventory. So hopefully over time we continue and should continue to improve our free cash flow position. As far as our capital expenditures, year to date, we're up $11 million compared to where we were at this point last year. We anticipate to continue to spend at elevated levels, not only for the rest of this year, but also as we look out for the next couple years, specifically around our continued expansions into our AST segment. We spent roughly $100 million a year over the last couple years on those expansions. And sitting here today, I would guess that we would continue to spend a couple hundred million dollars, at least annually, for the next couple of years going forward.

Okay, very good. Thank you very much. Appreciate it.

You're welcome.

Our next question comes from Chris Cooley from Stevens. Please go ahead with your question.

Good morning, and while I just want to say congratulations on your upcoming retirement, it's been a true pleasure to work with you this last decade. And I just want to also call out what a gentleman you are. You're acknowledging this morning what's always been an extremely strong and hardworking bench that I don't think has been appreciated as much by the street. But also, I want to acknowledge that you've always had a very astute, steady hand at the keel throughout the entire time. And you're going to be missed, but look forward to working with Dan. Maybe just two quick ones for me here this morning. First, when we think about what you're seeing more so on the health care side with capital in that build just trying to make it get a better understanding of what types of projects you're seeing there that drove that new record backlog in that segment and then secondly i would like to follow on the larry's comment regarding the cash flow which was extremely strong in the quarter especially in light of what's transpiring Just want to think, or maybe this is for Mike or for Dan, if we should start to step up our expectations for recash flow generation when we look at the yield versus the sales line historically. You're trending up, and clearly AST seems to be supporting that with higher margins. So just want to think about how we should think about cash flow on a longer-term basis as well. Thank you so much.

Yeah, Chris, on the healthcare capital side, we've talked about it a bit, probably less than we could ever should have. And the number of new products we have in the space right now is very, very strong. Virtually everything in our surgical line has been refreshed in the last 12 to 18 months. Booms, lights, tables, ORI. We have several new products that are in the infrastructure space. They're all doing nicely. So surgicals, clearly the operating room, what we call surgical is the operating room is very strong right now relative to last year. And IPT continues to be just an extraordinary piece of business on the capital side. So between the two. And I would say, although we had and still have a little trepidation about capital spending, when hospitals tend to pull back a little bit in capital, one of the last places they tend to pull back is with the surgeons who generate the income for the hospitals. So We have traditionally not pulled back as hard as some other areas when things go bad. That means we don't jump up as much when, you know, things get a little bit better. But I think it's a combination of, you know, there was a little gap when there wasn't so many orders. I think they seem to be back to quote-unquote normal, at least in our space, on the surgical and IPT space. So I'd say at a high level that's it. And I'll let the other guys talk about the cash flow question you asked us.

Yeah, so Chris, this is Mike. You know, obviously we are very proud of what we've accomplished this year from not only an earnings perspective, but also from a free cash flow standpoint. Although, again, as we are not giving guidance the rest of this year, we hope to give guidance, I would think, in the May timeframe for the new fiscal year. But one of the other things that you've got to be cautious about is, you know, as we do adjusted earnings on the P&L standpoint, we do not do adjusted free cash flow. So as we continue with acquisitions, especially the integrations, and the cost of those integrations, especially around Cantel. You know, we're going to be spending a significant amount of cash to get those cost synergies. So I'd be just cautious. If you were to back out and start doing an adjusted free cash flow, I would agree with you that it may be time to look at our stepwise change. But since we do not report that way, I would just be cautious of how you look at it.

Thank you. And our next question comes from Matthew Michon from KeyBank.

Please go ahead with your question. Hey, good morning, everyone. And Walt, I know you're leaving yet, but it's been a real pleasure seeing the evolution of startups over the last five, ten years. Congratulations. So in honor of you leaving, I'm going to ask some tough questions for Dan. Good man. As an initiation, So, Dan, if you average out the last three quarters for life sciences consumables, it's about 25% growth off a pretty good base, which is good. But I guess it's just hard to believe that new vaccine demand is only up 25%. Can you give us a sense of like the mix of life sciences consumables tied to vaccines? And then also, you know, when and where are your lifestyle consumables typically used in production in comparison to, and I know it's always been a tough comparison to getting, because it never really works out, but to the beta bags to clarify for folks trying to make a connection with their 70% order increase.

Okay. Thanks, Matt. And thanks for the challenge. So what I would say is, yeah. I think we've talked about it, and you stated it as well, on a year-to-date basis, our life science consumer business is up roughly 25%, give or take. And what we're seeing now is a little bit of pullback in terms of, you know, as our customers burn off some of the inventory they built early on in the early phase of the pandemic when there was a lot of concerns about surrogacy of supply. And we made it a point at Staris to serve our existing customers in pharma and and never deviate from that and sell outside of markets to make sure those folks knew that we would have those validated chemistries, you know, as demand, you know, continued to rise as they got into vaccine. You know, in terms of an actual percentage of how much is going to vaccine, it is impossible for me to say. And the reason why is that many of the vaccine manufacturers are also, have been long-term large customers of Staris that use our product. or from a bioprocess cleaning perspective in their normal day-to-day production of pharmaceuticals and biopharma. So it's not as if we're tracking down to the shop floor level as to every application our products go into. What we know, though, is that we are getting some upticks from vaccine as our customers sort of refocus in that area, especially around COVID. And we believe that'll be a trend that continues. In terms of the beta bag product, that's a sterile transfer product that has an integrated lift or an isolator. It's not something we do. We are in the space of sterility maintenance and sterility assurance as it relates to bioprocess, no doubt, with our barrier product solution group of products, and those have continued to do very well since the beginning of the pandemic. They've done well since the time of acquisition, actually, but They've done very well since the pandemic really started, and those products are up as well and have stayed fairly consistent in terms of their growth as opposed to slowing down, as we've seen in the chemistries piece. Specifically on the chemistries, we have mainly two offerings there. One is what we call critical environment products, and those are disinfectants and sterilants. that are largely used in either aseptic manufacturing process or highly regulated clean rooms for pharma manufacturing. Now, not a lot has changed in terms of their application with COVID. There's just more application as it relates to increased vaccine production. And then the other large portion of our consumer business is what we would call bioprocess cleaners. And those are chemistry used for cleaning out the actual bio-pharma equipment used in the manufacturing process. So, in between production runs, they assure they have the highest level of purity in terms of how they treat their machines and stainless steel in the process.

Okay. Excellent, and appreciate that answer, and well done, Dan, to start. Just going back to capital equipment, What was the impact on the backlog from the accounting change you made earlier in the year? Is it masking a higher year-over-year number? And then to continue with asking multiple questions, how should we think about orders versus shipments, especially as hospitals transition from the COVID surge to non-COVID surge through the course of the calendar year?

Matt, I'll take that first question about the impact of, so when we made the adjustment in the first quarter for the ORI deferral, we are starting to recognize that revenue as it is shipped rather than on install. It was about a, I think about $15 million deferral. uptick in revenue in the first quarter. And throughout this year, we've gotten rid of the backlog, if you will. But last year, it is still reflected in the backlog. And if you look year over year, there's about $12 million in last year's backlog. So if you need to adjust last year's backlog, if you want a true apples to apples comparison, if you do that, obviously, we would be at an all-time record. But that's why we're near our record backlog because of that impact.

Yeah, we'd be $12 to $15 million over last year and $12 or $13 over the best year we've ever had, the best spot we've ever had. And then the second question, sorry.

Yeah, how should we think about orders versus shipments? I mean, obviously hospitals are obviously still dealing with the COVID surge. And are they placing longer-term orders or are these – Are these orders in which they're like, let's just build now and replacement?

Yeah. As you know, our typical pattern is kind of 60-40. We have been a little stronger, heavier, whatever term you want to say, in terms of the big projects recently. But, you know, in order for us to have record order months and record orders, backlogs, they both have to be chugging along. So it is running much more like normal than it was, for example, six months ago.

And then the last piece for me would be, how should we think about the operating margin level as compared to where we're at today as sales growth returns, your mix begins to normalize and you integrate two large acquisitions?

You know, that's a lot of moving parts.

And so that is a lot of moving parts. Obviously, the areas that have been very strong have tended to be toward our higher margin products. So there has been a bit of a mix effect. And as we ship more of the capital and as we do more of that, there will be some, I'll call it mix effect, But as you know, we don't plan on keeping our costs the same level ever. And so we are working to reduce costs, some of which we pass on through lack of price increase to our customers, some of which we take to the bottom line. So that's one set of mixes. And then as we bring the other businesses on board, you know, it depends on which parts of those businesses are coming in. There is a natural mix effect. But on the other hand, given the level of synergies that we see, we think we will be offsetting that. So we think that if you were to look at it in a pro forma basis, if you will, how those businesses all look today and add them together, the margins are going to go up because we're going to take more than $100 million out of the businesses that are coming on board. So we feel very good about that. And you know from our long association that I only care about growing profit dollars. And as long as we can grow profit dollars double digits, that's what the team's mandate is. And if the margin happens to go up 10 basis points or down 10 basis points, I don't lose any sleep over it. But in the end, it's pretty hard to grow revenue at high single digits and margins and then profits at double digits unless we grow margins, and that's our mandate.

Excellent.

Thank you very much. And our next question comes from Mike Mattson from Needham & Company. Please go ahead with your question.

Yeah, thanks. So I just want to go back to the capital orders question. in the healthcare business. Do you think any of the strength you're seeing there is because of pent-up demand, sort of things that were deferred in 2020 because of the pandemic? And do you think that if that's the case, I mean, is that something that could be sustainable for some period of time?

Yeah, Mike, this is Dan. I do think that we are experiencing some of that effect. And specifically, I mean, we had a really tough time with sales reps getting access for three, four months, give or take. And just don't ever underestimate the ability of a sales organization's ability to sell. And being present is very important. So I think there's some catch-up, you know, in those numbers. But generally speaking, you know, when we talk to customers and hospital systems, you know, there is a concern about the surge after the surge. And that is what's going to happen with all these backlogged surgeries that are elective or semi-elective. once we get back to a normal steady state in terms of COVID and operating. So I think that's also helping us in terms of the sustainability of the capital backlog and the orders we're seeing.

Okay, thanks. And then just more of a housekeeping question. I was wondering about the – you're excluding some COVID-19 incremental costs from your adjusted EPS. This isn't the first quarter, obviously, that you've done that. But I just wanted to ask about if you could clarify what those costs are and kind of how you determine how much falls into that line item. Thanks.

Yes, certainly, Mike. And we've been, I'll call it consistent, if you will, all year surrounding this. And the makeup of that is, as we have put forward, employees on furlough. And when I mean furlough, they're not doing anything for the company, so they're just off completely. So we've taken the opportunity to capture those costs. Also, we've been able to get some government reimbursement for those folks at the same time. So we're netting that cost into the adjustments. In addition to that, We have had to put in some training tools. We've done some enhanced cleanings, some different protocols that we've also done in our facilities across the globe. We've made some modifications to our buildings. Obviously, traffic patterns have changed, signage has changed. So all of those costs surrounding that is what we're capturing today. And we're identifying separately as the COVID incremental costs as we're adjusting those out. To date, we're about just over $20 million for the first nine months. And that has significantly dropped from the first quarter levels. And we anticipate it will continue to drop as most, if not all of our employees are back to work. And recall, we were also very proud that we did not have to lay off anybody. This was our intention of keeping our folks whole. And when our customers were ready to come back to work, we were there right alongside with them.

Yeah, I think Mike pretty much described it. Just to be clear, those furloughed employees are all paid 100% of their base pay. And so the governments of the world, depending on which part of the world they're in, make up some portion of that, but never all of it. And so that's been the cost. And that's really the most significant cost that we have captured. And in most cases, where there is, and certainly where there's a government subsidy, it's absolutely clear that they cannot do anything while we're, while they're on furlough, if you will. And we have taken that approach on anyone who we have captured in this is that they are absolutely not working and absolutely being paid 100% of their pay.

Okay, got it. Thank you. Once again, if you would like to ask a question, please press star and then 1.

And our next question comes from Michael Polark from Baird. Please go ahead with your question.

Hi, good morning. A question on the leadership transition. Two-parter. Number one, would you expect a backfill for Dan's COO role, elevate somebody else in your organization? That's part one. And then part two for Dan, Dan, how many direct reports do you have today? And once you get up and running in the new seat, how many direct reports would you expect to have at that point?

Yeah, sure, Michael. Thanks. So in terms of Baxill, I would say no, not in the existing role. I would not expect us to operate going forward with a COO. And in terms of my direct reports, currently, you know, I have eight or nine, give or take, right now. And what I would say is, you know, it's likely, you know, with the acquisitions coming in and some changing roles within the organization, that the number of direct reports I have on the commercial side of the business will consolidate to some extent. under leadership that we have in place. So I would expect that, you know, it to be in that direct report, whether that's, you know, 8 to 11 or 8 to 12 or, you know, something like that. But I think over time we'll sort of transition to something that looks more like that.

And then my second, yeah, yeah. If I comment on that, that's 8 to 12 is kind of what we think senior executives should have. And You know, it's a heck of a lot easier to save money if we all have 8 to 12 and we don't have four extra chiefs running around. And so that's been a hallmark of one of the ways that we operate efficiently is virtually everyone on my staff, virtually all the time, except, by the way, for me right now, I'm almost on vacation. I think I have three or four left. But everybody else is 8 to 12, and that's just kind of the way we operate.

I appreciate that, Culler. The second question was on the Kintel transaction. It sounds like there is no new news in terms of the timeline. Would just be curious for a brief update there, the discussions with regulators, how are those progressing? And then has there been a date set yet for –

Yeah, it's still too early for any real news there. We're going through the process and determining the various countries we do or don't need to file in and then getting those files in.

So it's way too early to comment at this point.

And ladies and gentlemen, and having no additional questions, I'd like to turn the conference call back over to management for any closing remarks.

Thanks, everybody.

And ladies and gentlemen, that will conclude today's conference call. We do thank you for joining. And I'll disconnect your line.