STERIS plc (STE) Q1 2020 Earnings Report, Transcript and Summary

Good morning and welcome to the Steris PLC First Quarter 2020 Conference Call. [Operator Instructions]. I'd now 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 Rosebrough, 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 expressed written consent of STERIS is strictly prohibited. Some of the statements made during this review are or may be considered forward-looking statements. Many important factors could also cause actual results to differ materially from those in the forward-looking statements including without limitation those risk factors described in STERIS's 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'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 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 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%, 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% to $105 million and 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 a 100 basis points from our original 5% to 6% range. The updated revenue forecast suggests that the outperformed -- out performance 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, our Health care Products and AST. Health care 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 V-PRO 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 grow 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 and 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, we are -- 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 FY '20, will be at the low end of our original guidance of 19% to 20%. 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 $0.10 from our original outlook. While our first quarter exceeded consensus by $0.12, it did not meet our internal plan by that much. As a result, we continue to expect earnings in our revised forecast to be weighed 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. He has served on our Board ever since, and he has made innumerable contributions over his tenure. Dr Michael Wood has been a Board member for 15 years and has brought a unique perspective in the surgeon former CEO of the Mayo Clinic. And sir, Duncan Nichol 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 longstanding 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 him the very best. In closing, we started this year strong and continue to expect another year of record performance in FY '20. 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 [Operator Instructions]. The first question comes from Matthew Mishan with KeyBanc.

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

Thanks, Matt.

Walt, Mike, can you guys start off with AST and if you can 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 has been some, but I think we reported last time some modest increase probably due to Brexit in Europe. There has been some modest increase due to the Chicago closing that you refer to. And then there has been just good underlying generic increases. We've talked about this before, we continue to put capacity in places where our medical device customers are expanding. And we haven't seen our the OEMs who are making these devices generally speaking, haven't been building capacity for that growth. So by definition there outsourcing or 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. So 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 a [indiscernible] for lack of better terms true growth in 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 [indiscernible] ORC business.

Matt, this conversation is not dissimilar from what we've been saying and that is, that 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 the pipeline of people who are interested in doing things continues to grow and we feel very good about the growth prospects going forward.

Alright, and then lastly, international versus US. There has been other companies that have indicated there has been some international cap equipment delays. Any -- trends you're seeing like differently there versus here.

Yes, we've seen Europe is kind of flat. So if you look at that relative to the US, no question that it has not grown as the US. US has been hot now for a while and continues hot in our view. Latin America for us is kind of picked up. Since the relative volume there is small it's hard to tell. If we just picked up some orders or if the market is a little stronger. But we feel much better about Latin America and Asia Pacific has also done nicely. So we're comfortable there. So that the 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.

The next question comes from Chris Cooley with Stephens.

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 raised guidance on the first fiscal quarter. And it's been some time. I guess –

I suspect, Chris you haven't found one.

That's right. But my -- we started to lose me now at this age. It is a. So I guess 2 quick questions from me one, when we look at the quarter, obviously it was very, very strong. But if we did want to knit 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? Well, 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, what you're seeing in the capital environment -- healthcare capital environment in the short run, and I'll have a quick follow-up.

Yes, Chris. We're not seeing any deceleration of, I'll call it pipeline or order pipeline coming in. In fact, if anything, it would be the opposite. So backlog is a relatively small piece of orders and it's orders might have 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 order rates pipeline, we're not seeing any decline. So this is a temporal change, which often happens and capital in any given 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 then concern. There is some point in which in fact we have 2 types of orders some that ship in 12 to 18 months and some the ship in and use of more like 6 to 9 in and 12 to 24 in Life Science. But there are some points, if you have a lot of your backlog, it is asap type backlog having too much actually is as a problem. So we have a bunch of [indiscernible] 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 forwarders.

And Chris, this is Mike. The other number that that what you are correct in the 6% but if you look at sequentially, we are 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 is any concern on our end.

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

Appreciate the additional [indiscernible]. It's what I thought. Just lastly then for me when you look at AST but if you've got a new high watermark for operating margin in the quarter. Looking back here historically, which is really impressive. So 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 watermark as we go to the fiscal year, or is this kind of the new normal as we model that business? Thanks so much.

Sure, Chris. Great question. And 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 we will see temporal fluctuations in those numbers and right now we're running pretty hot. I wouldn't bet my life on 40% the rest of time, but I mean obviously we've been 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 Rodgers with Great Lakes Review.

Yes, just looking at your improved outlook on the Healthcare Products 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?

Yes, you know on that I've forgotten exactly the number, but we have something in the order of 20 -- 30 new products that we introduced last year, which really what's filling the pipeline for this year. And we have 23 new products that we're going to introduce this year and I might even be a little on the Life side on the Healthcare Products 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 Australian assurance products are growing quite nicely for us right now. We have a number of new products in that space. V-PRO is driven not by new consumable but by new products, new capital products as we place those new capital products and we have just a completely new line of V-PRO now and those new capital products dose do drive the consumables or allow the consumables to grow so. And then our ICC business again We have multiple new products in [indiscernible], cleaning chemistries and those are just continuing to take hold. We think we have the best line in ICC now by a margin, significant margin. So they continue to grow. So it's not any one product and there is 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 in the things that go with them ORI and tables 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 the tariffs. I mean, I think it's that material, but I just wanted to check on that.

Good check is 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 of 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 Mitra Ramgopal with Sidoti.

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 would half this year and a half next year in terms of --

Yes, Mitra. 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'm just wondering if you had any additional color on that.

Yes, we did a small acquisition in middle of the quarter, it was a systems acquisition in our health care 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 is obviously been a little lumpy in the past, but if you look at it last couple of years it's actually been holding up pretty well. I was just wondering if you think going forward, we should continue to kind of see these numbers in terms of where the backlog is.

Yes. 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 or backlogs remain roughly in the $60 million range. And when we're in that range of backlog, we feel we can do these numbers 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 single digit, low-single digit kind of growth, not atypical of capital equipment. But it is lumpy. This last quarter. I, it's 35%. -- 40%, up so and the previous quarter was off 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 $1.5 million a piece. So you get a couple of those together and you have a really good quarter for a couple of slip into the next quarter. You have a weak quarter. But, we're pretty comfortable sustaining that level at this point in time and our visibility, how the future looks that way as well. So we're pretty comfortable there. The consumable side is continuing to grow very nicely and we anticipate that continuing.

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

Thank you.

Thank you. [Operator Instructions]. The next question comes from Larry Keusch with Raymond James.

Good morning, everyone. So two questions, Walt, you know 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 high quarter. And I don't think we would characterize our entire business growing 10% a year going forward. So obviously, I mean the math suggests a slowdown. I haven't done the actual numbers, myself, I'm guessing in the 5% to 6% range, something like that to get to that, which is well within our normal range. So we had a high 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 a reconciliation.

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

Yes, Larry, this is Mike. So what 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 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 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 on the pound are largely service businesses for us, it's heavily, more heavily with the service as opposed to product. So the revenue and cost travel together, but the margin component shrinks, if it's -- if those currency shrink, but I would say to 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 UK. 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 5 or 6 currencies that reeled off where we have manufacturing plants to all be moving in the same direction against everybody else. So we are more naturally hedged, both on a profit basis and on an overall can we sell things with that against tougher currencies we're more heads 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, Larry.

Thank you. And the next question comes from there [indiscernible] with our JMP Securities.

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

Yes, I know you're exactly right. We clearly are seeing strength in medical devices, in terms of volumes. Every hospital I've talked to recently tells me there are always busy, 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 and for our purposes, we don't really care if the surgery is inpatient or outpatient and by the way I use surgery in the broader sense, it can be any number of procedures like in this capex procedures where our US industry business works really well if they're doing those procedures. So it's procedures in hospitals and-or ambulatory surgery centers and 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 and for the long term, we have the baby boom in North America. Running through it in much of Western Europe and that baby boom wants to have new hips and new shoulders, and a sculpt knee and multiple other issues and as fast as ambulatory surgery is growing, which it is and ambulatory surgery in the US, at least the fastest growing area for our business as fast as it's growing, it's also getting more complexities. So, 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 surgery being done in the acute settings. And so even though it looks like oh gee! We only did 5 surgeries, but if 2 of them were double transplants that's very different than doing 5 sculpt knees. So I think both the complexity of surgeries in acute care continues to rise. In ambulatory surgery we're seeing faster growth in 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 across 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 and 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 Mishan with KeyBanc.

Great. I mean you just have a follow-up to David's question. I guess is how has your value proposition to the hospital system, kind of, especially with the rise of in share of the ASCs changed over like the last couple of years.

Well, you know, Matt, I would say, I don't think it's radically change in a couple of years. But what we have done as you have seen as we bring more and more products and services around this procedural space. And so we are stronger today do the family of products and services, bringing in IMS, so we can help them with their surgical instruments. Bringing in the ORC concept, bring in the mobile units that were if they are out of capacity we can help them out. In addition to all the new products and services that we brought into the Healthcare Products. We just are a much stronger entity and more able to help them in many different ways in the procedural areas. And so, but I wouldn't call it a radical change in the last 2 years. But if you look at the last dozen years. We're a very different entity when we're facing the hospital procedures that we were 10 years ago, let's say.

Okay. And then, last quarter you talked a little bit about some kind of stocking ahead of Brexit. And you talked about as well as a shift in manufacturing in Life Sciences positively impacting sales of by about $5 to $10 million. And then you also talked about a headwind from your larger restructuring that you are absorbing on top of that. Can you just talk a little bit maybe about the timing of those? And when do you expect to see, to see that those shifts through 2020?

Yes, Matt, great question and I'll kind of try to walk through the 2 or 3 items that you mentioned, actually. First of all [indiscernible] these Brexit and well it vis-a-vis Brexit we said at the time we were pretty sure there was about 5 million pull forward and we had no idea how much else it might be. And so we were guessing in the 5 to 10 million range. We still don't really know because we don't have visibility to all that space. But the fact that the quarter stayed very strong suggest that it wasn't 10, that it was probably closer to the 5 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 known numbers times 2 or 3 or 4. 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. I but I wouldn't see I think it 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. So 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 in 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 that we're over that, that's done. That's part of the reason we feel comfortable, even more comfortable with our forecast because we absorb that without a loss, but it's still was at our plan. So we absorb that one. And in terms of the, with the product closures that will still be out there over probably the next 12 to 15 months, but it's relatively small numbers will be spread over a larger number of months. So I don't think you'll notice. I think I hit all the topics there Matt.

Yes. 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 to Steris. Have a great day.

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