STERIS plc (STE) Q2 2027 Earnings Report, Transcript and Summary

Good day, and welcome to the STERIS plc Second Quarter 2027 Financial Results Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Julie Winter, Investor Relations. Please go ahead.

Thank you, Nick, and good morning, everyone. Speaking on today's call will be Karen Burton, our Senior Vice President and CFO; and Dan Carestio, our President and CEO. 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 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 cause actual results to differ materially from those in the forward-looking statements, including, without limitation, those risk factors described in STERIS' securities filings. 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 in our 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. With those cautions, I will hand the call over to Karen.

Thank you, Julie, and good morning, everyone. It's my pleasure to be with you this morning to review the highlights of our second quarter performance. For the second quarter, total as-reported revenue grew 9% to $1.6 billion. Constant currency organic revenue grew 8% in the quarter, driven by volume as well as 230 basis points of price. Adjusted gross margin for the quarter was 45.3%, up 100 basis points versus the prior year. Margin expansion was driven primarily by tariff refunds of approximately $20 million during the quarter, which added 130 basis points year-over-year. Underlying margins were down slightly as favorable price was more than offset by inflation. Gross tariff costs were approximately $15 million in the second quarter, flat with the prior year. For clarity, tariff refunds are not being allocated to our business segments, but instead are booked to corporate to enable business segment analysis. Adjusted EBIT margin was 24.6% for the quarter, up 150 basis points from the second quarter last year. Tariff refunds contributed 130 basis points to the increase. Underlying margin improvement benefited from favorable price and volume, partially offset by inflation and investments in the business, including the acceleration of R&D spending. We do not expect any material additional tariff refunds during the remainder of fiscal 2027. The adjusted effective tax rate in the quarter was 25.3%, an increase from 24.5% in the second quarter of last year. The increase was primarily driven by unfavorable discrete items. Adjusted net income in the quarter was $286.8 million compared with $244.5 million in the prior year. Adjusted earnings per share were $2.94, a 19% increase over $2.47 in the second quarter of last year. Excluding tariff refunds, adjusted earnings per diluted share grew 13%. Capital expenditures for the second quarter were $76.1 million, and depreciation and amortization totaled $125.6 million. We ended the quarter with a strong balance sheet, reflecting $1.9 billion in total debt. Gross debt to EBITDA at quarter end was approximately 1.1x. Free cash flow for the first 6 months was $492.5 million compared with $527.7 million in the prior year period. Cash flow from operations was $656.1 million compared with $707.8 million last year. The decline in cash flow was driven primarily by significantly lower contribution from working capital as we utilized cash to build inventory in support of second half shipments, partially offset by higher net income. Share buybacks in the second quarter totaled $100 million or $200 million for the year-to-date. We have $800 million remaining under our current authorization. During the quarter, we approved an additional restructuring plan covering targeted facility realignment, product rationalization and select organizational realignment. We anticipate total charges of $45 million, including $10 million in cash expenditures and $35 million in noncash charges. Approximately $25 million was recorded in the second quarter. The plan is expected to generate annualized savings of approximately $9 million with a portion realized in fiscal 2028 and the full benefit in subsequent fiscal years. With that, I will now turn the call over to Dan for his remarks.

Thanks, Karen, and good morning, everyone. Thank you for joining us to hear more about our second quarter 2027 performance and our outlook for the remainder of the year. Karen covered the quarter at a high level, so I will add some commentary on our segments. Starting with Healthcare. Constant currency organic revenue grew 7% in the quarter. Our performance reflected solid underlying demand with continued strength in our GI business. The strength of our portfolio and commercial teams enables us to help our customers navigate a complex operating environment. Service continued its streak of outperformance, growing 10% in the second quarter. Consumables grew 10%, benefiting from increased customer consumption and driven by share gains, procedural growth in endoscopy and to a lesser extent, a recent acquisition of GI products. Healthcare capital equipment revenue increased 4% in the quarter, also benefiting from a recent acquisition. Orders remained stable with 1% growth in the second quarter and our ending backlog increased to $456 million. EBIT margins for Healthcare in the quarter decreased 110 basis points to 24%. Improvements in volume and price were more than offset by inflation, lower productivity and longer-term investments we have accelerated on the back of tariff refunds. Turning to AST. Constant currency organic revenue grew 5% for the quarter with 5% growth in services as reported or 6% constant currency. We ended the quarter on solid ground and early indications suggest that October is holding those gains. EBIT margins for AST were 44.7%, a decrease of approximately 60 basis points from the second quarter of last year. The decline reflected increased depreciation and inflation, somewhat offset by improved pricing. Constant currency organic revenue increased 18% for Life Sciences for the quarter. Supporting that growth, capital equipment grew 53% and consumables increased 9%. Service revenue grew 5%, reflecting strong shipments. Backlog was $93 million at quarter end, down a bit from prior year. Margins were a record 44.4%, an increase of approximately 310 basis points, reflecting improvement in volume, price, productivity and favorable mix. Reshoring and localization of manufacturing are benefiting our Life Sciences segment. Turning -- before we turn to the outlook, I do want to discuss our recently announced agreement to acquire Xodus Medical, a surgical specialties products business focused on patient and OR staff safety. Xodus Medical is a natural complement to our Healthcare portfolio, expanding our consumables offering and the way we support customers in the operating room. The business is well known for its flagship Pink Pad, a single-use surgical patient positioning product, but its portfolio is much broader. The products span patient positioning, patient handling and transfer, patient warming and operating room essentials. This highly clinical single-use portfolio will strengthen our recurring revenue and expand our direct commercial presence in the OR. Xodus has consistently demonstrated impressive growth driven by a steady stream of innovation and highly effective commercial model. Our go-forward model reflects maintaining revenue growth in the mid-teens and EBIT margins in the low to mid-50s. The competitive clinical position is well defined and supported by clinical studies, AORN guidelines and a solid innovation pipeline as well as intellectual property protection for core products. We are very excited about the opportunities ahead as our company align to better serve customers. Shifting gears to outlook. Based on our second quarter results and our expectations for the remainder of the year, we are updating our outlook for fiscal 2027. Our total company revenue growth expectations remain unchanged, including as-reported revenue growth of 7% to 8% and constant currency organic growth of 6% to 7%. Our fiscal 2027 earnings per diluted share outlook has been increased to $11.35 to $11.55 compared with our prior range of $11.10 to $11.30. This includes approximately $0.18 per share benefit from tariff refunds year-to-date in fiscal 2027. The additional increase in outlook was driven by second quarter outperformance and lower interest. From a segment perspective, we continue to expect Healthcare constant currency organic revenue growth of 6% to 7%. We now expect AST growth of 6% to 7% previously compared to the 7% to 8%. This revision reflects us maintaining our exit rate for the second quarter for the balance of the year. Based on the strong first half, we are increasing Life Sciences constant currency organic growth outlook to 9% to 10% compared with 6% to 7% previously. This reflects a return to more normalized growth in the second half of the year and the outperformance in the first half led by capital equipment. All other elements of our most recently provided outlook remained unchanged. But as a reminder, this outlook does not include Xodus Medical, and we will update our expectations after close. This is a very exciting time at STERIS. The business continues to perform very well, and we are able to prioritize investments in the business that will support our growth for years to come. I want to thank all of our associates for continuing to do what they do best, focus on our customers and strive to do a little better each day. That concludes our prepared remarks for the call. Nick, would you please give the instructions and we can begin the Q&A.

[Operator Instructions] The first question will come from Brett Fishbin with KeyBanc.

Maybe just starting with the acquisition of Xodus Medical. Definitely seems like a nice fit for STERIS. And I was just curious if you could discuss a little bit more than what you provided on why this was particularly attractive for the company? And then just more broadly, how you think about this new call point as a longer-term opportunity for the Healthcare business?

Thanks, Brett. I appreciate the question. Yes, we're very excited about the planned acquisition of Xodus. And you mentioned it, but it gives us a new call point and a real clinical sales force in the OR, which we really don't have today. I mean when we sell our surgical infrastructure, our capital products, lights and tables, [indiscernible], that's more on a build type architectural-type [ sale ]. This really gives us an everyday call point and a reason to be in the operating room, which is the beginning of reprocessing or the end of reprocessing depending on how you look at it in the total perioperative loop. So they have great products. They're high margin, high growth and consumable and have had a great trajectory of performance for 7, 8 years now, I would say. The product has a lot of customer acceptance and appreciation. It's supported by AORN. And we just think it's going to be a great add for STERIS.

All right. Awesome. Awesome. And then maybe just one more question on the guidance. I think the AST topic has -- or sorry, the Applied Sterilization Technologies topic has just been a little bit of a conversation, and you had a competitor talking about some incremental headwinds in Europe around just overall activity levels. So I was curious if the change to guidance -- the slight change to guidance is more to do with continued inventory dynamics or if you're also seeing some type of slowdown or weakening in any particular geographies?

Sure thing, Brett. So what I would say is this, we had a slow start to the year based on really difficult comps. As we started into Q2, which we just ended, obviously, we saw that improve, especially in September, and those improvements continued through in October. So we feel pretty confident in the back half that we're going to be somewhere in the 6% to 8% growth for that side of the business. And that's supported by the numbers we've seen thus far. I would not say there's a reason. In fact, we obviously do listen to the others' reports, and we actually had better growth or as good or better growth in Europe last quarter than we did in North America. So I think it's just pockets of different customers and things that happened that caused some things. So I wouldn't read too much into that. In terms of general volume in the U.S., we've said this before, we expect it to be procedural growth at the lower end of the range, which is somewhere around 3% instead of the high end of that range, which can be 5%, which drives consumption of all of our businesses for the most part.

The next question will come from Patrick Wood with UBS.

Maybe for the first one, just to jump on AST again as volumes start coming back. Where are we at very roughly or qualitatively in terms of utilization? I'm sure EO is pretty tight, but obviously, things like gamma, the fixed costs of the half-life outside of things, you can get a lot of torque as volumes begin coming back moving through the P&L on margins. So like are we going to see as volumes begin to come back a little bit of leverage coming through on those facilities? I'm not sure where utilization sits today versus history.

Thanks, Patrick. This is Dan. Well, total utilization across the network is pretty high, but we have room effectively everywhere because the volumes are slightly less aggressive than what we thought they were going to be at the beginning of the year. So as volumes do come back on the existing infrastructure that we have in place and capacity that we have installed, because we never slowed our isotope loading or anything like that because if you miss it, you miss it forever. So we've kept up with our loadings. We have adequate capacity to take on the increased demand as it flows through. And yes, you're right. The difference of a couple of percentage points, it makes an awfully big difference in terms of drop-through at the margin line. And some of that's offset that we've got some new facilities that are in ramp-up mode. So those obviously aren't contributing margin at the same level as a very mature facility. So that has somewhat of a dilutive effect, but those are, for the most part, already in the P&L. And so any improvement in volume should show through.

Super clear. And then just quickly, the -- on the Healthcare business, obviously, of the capital equipment line, a chunk of it is essentially non-optional, obviously, because you're going to have to be sterilizing. But you have some that's a little bit more surgically connected in that side. And I guess maybe it's a bit off the beaten path, but the 340B reform rules were kind of finalized, it looked like last night. We're all debating on what effect that could have on hospitals or those hospitals P&Ls that were relying on it a little bit. I don't know, have you heard anything from customers in terms of their CapEx outlook, whether that would affect them? Or is it just more of the same?

It's more of the same. In fact, we actually had a really great order quarter on our surgical products this past quarter. So -- and there's a bit of a shift going on in Healthcare today, where the plan is as our population ages here domestically anyways, hospital is going to have to push healthy patients out to their ASC networks for procedures, and they're going to have to take higher acuity patients into the large acute care facilities, which are going to require more capacity in those locations. So we haven't seen any slowdown on the capital whatsoever. Our backlog in Healthcare is pretty much near record if you exclude the supply chain crisis a few years ago. But -- so we feel pretty good about that.

The next question will come from Mac Etoch with Stephens.

Maybe just starting on the Life Sciences segment. You previously disclosed that onshoring could be more of a longer-term benefit. But given some of your prepared remarks, can you just expand on what you're seeing today and how you're thinking around some of these broader macro factors are developing versus maybe at the start of the year?

Yes. I think the difference today is that some of the plans that were previously announced by our customers for expansion in the U.S. and also some of the juxtaposition of manufacturing in Europe were just that, but now they're starting to materialize, and we're starting to see orders from a capital equipment perspective. But also we're starting to see requests for work on our chemistry side of the business as well. Now having said that, this past quarter was the outperformance there. We had a great order shipments quarter, but there was one particular order that really made a big difference that was in excess of $10 million for a single customer. So that would move the needle. That one won't be replaced on a quarterly basis. But nonetheless, we expect great performance by Life Sciences throughout the end of the year.

Got it. I appreciate that. And then maybe just quickly touching on tariffs as well. I think you all cited $24 million as being the total pool of available tariff refunds for the year. Has that shifted at all? Is that available pool widened? I know you're not factoring in anything additional in the guide, obviously, but I just want to get a sense there.

Thanks, Mac. Yes, this is Karen. The tariffs that we have received of $24 million is what we expect to receive. The total IEEPA tariffs paid last year were $27 million. So we've got about $3 million where there's just no refund program right now to recoup those. So we are not projecting receipt of those.

[Operator Instructions] The next question will come from Michael Polark with Wolfe Research.

Dan, curious if you could bridge Healthcare consumables growth. I know there's small M&A flowing through, but 7% last year, call it, high single digits solidly year-to-date with AST volumes being muted. What's the disconnect there? Why is Healthcare consumables growth at a high level, kind of growing at a much higher rate and AST volumes still kind of seem tempered?

There's an easy explanation, Mike. So the reality is over the last few years, we've placed an awful lot of dedicated chemistry equipment out there. And those are things like V-PROs and our washers and obviously, AERs. And as a result, that share gains that we've been delivering on the capital side is now converting into consumables growth. In addition to that, a lot of our chemistries franchise in consumables and Healthcare is weighted towards endoscopy. It's the chemistry that goes through our automated endoscope reprocessors. And we've had a really great year thus far on placements of new machines. And in addition to that, the general growth rate of endoscopy has remained strong. When I talk about general growth rate, I mean procedures has remained mid- to high single digits consistently. So there's a bit of a bias in our Healthcare consumables business towards endoscopy.

I'll follow up on that. That was one of my other topics. So I heard, yes, just now and then in your prepared remarks, the GI enthusiasm reaffirmed. There is a competitor there that has some challenges in the U.S., Olympus, I'll say the name, so you don't have to. Obviously, you don't sell scopes, but they sell reprocessors and maybe some accessories. And has that been a benefit worth spiking out in your GI business? Or no, this is not a share gain execution in market.

Mike, it's been a benefit, but it's minor. I mean it's been a quarter or 2 of improved AER sales. But I mean, there's an awful lot of those machines out there still. So over time, we'll continue to do well, I'm sure. But like I said, it's been a help, but it's been insignificant in the grand scheme of things.

The next question will come from Mike Matson with Needham & Co.

So I just want to ask another one on Xodus Medical. By our rough math, it seems like this could be a fairly accretive acquisition to EPS. I mean we're coming up with kind of 3% to 5% EPS accretion on an annual basis. I mean this business has extremely high operating margins. I don't know if you're willing to comment on that or I assume you'll -- maybe you'll give us more information when you actually close the deal.

Yes. Mike, this is Karen. We will give updated guidance once we close the deal. And certainly, we expect it to be accretive top to bottom revenue margins and EPS. But I would encourage you to make sure you're including all of the interest costs as we are funding this deal with debt.

Okay. Yes. I mean we were assuming around like a 6% interest rate. Does that sound in the ballpark?

It certainly does.

Okay. All right. And then there was some commentary earlier in September at an investor conference about destocking in the AST business by your customers. So I think you've kind of addressed that in a way by saying you saw it get better in October, but I just wanted to see if you could elaborate on that commentary a little bit.

Yes, sure, Mike. Thanks. Yes, I think at this point, we're confident to say the destocking has ended. We think it washed itself out in the last quarter that we just completed. And then we've seen more normalized growth at the back end of that quarter, and then we have pretty good revenue growth in October, which we normally don't hit on, but given it's relevant as to what we've been saying for the last 6 months that first half is going to be tough and then we got easier comps in the second, we're confident in delivering that message.

The next question will come from Jason Bednar with Piper Sandler.

I'm going to try one here on AST. That's a little bit of a follow-up to some other questions. But just for clarity, so change in growth guidance here, it's a function of some softer procedure volumes, I think. But can you put a finer point on what you're expecting in guidance with respect to volume growth across your U.S. and European customers? Are you assuming the better volume growth, the better performance in the business that you referenced, Dan, in September and October that, that persists for the rest of your fiscal year? Or what's the sensitivity on improving or softening from here knowing that the macro still has a layer of uncertainty to it?

Yes. It's -- honestly, Jason, thanks for the question. It's kind of simple math. And what I mean by that is last year, first half of the year that we are comparing to, we grew over 10%, right? And then that slowed significantly if you go back and look at the constant currency organic numbers to mid- to low single digits. So just the comps and growth become a lot easier to get to as we started seeing destocking in the third quarter of last year. So as a result of that and based on what we think is a very stable health care operating environment right now, we're confident that against those easier comps, we should be able to deliver much higher than we did in the first half.

All right. Maybe one follow-up to that, and then I got a separate question. But I think a lot of investors are really trying to understand like a little bit of the sell-in, sell-out dynamic on what you're seeing and understanding you're a layer removed from the sell-out, if you will, the actual procedure volumes. I mean, are you seeing anything different that's shifting just because there is a lot of information that's flowing out there suggesting some softer volumes. So I guess just, again, trying to understand if there's anything there. And then the separate question here, maybe Karen, this is for you. I mean can you talk about what's stimulated another restructuring program? Just strategically, it seems like these are maybe becoming a little bit more common in the last few years. So is something changing with respect to how you're approaching operations in your portfolio?

Thanks, Jason. I'll start on your question on the volumes. You talked -- you used the word softer volumes. And I think this is way, way overplayed. I mean the fact of the matter is that there are some highly elective procedures that have been and will get deferred. And some of our peers in different segments of highly elective products have talked about that. Some have contradicted each other as well, so in terms of what they're seeing. So I think that is what it is right now. There's still great growth going on in Healthcare in terms of general procedures. I've said and I've been clear that it's at the low end of the range, meaning if we always sort of assume somewhere between 2.5%, 3% and 5% procedure growth rate, especially for North America, we're probably down towards 3% right now. But it's still growth rate, right? It's not negative. We're flat. And we have a mountain of data from all the SPDs, sterile processing departments that we run across North America and the U.K. and other places in Europe that says that the number of trays and consumption is up. So based on everything that we're looking at, although there's economic stress clearly for our customers, in particular, in North America, there's still a high level of demand.

All right, Jason. I will talk to you a bit about restructuring. So the new plan is targeted in terms of some smaller actions. That would include some key components like elimination of a single-use urology scope from our product portfolio. So the costs include disposal of inventory, termination of supply contracts, impairment of intangible assets. Another key component is some small site consolidation, including transition of production of our sterility assurance products to the new Mentor manufacturing site that was announced early in fiscal '26. The plan that was announced in August in conjunction with the announcement of the formulated chemistry Center of Excellence was 100% focused on that action and the impact of that center of excellence. So we kept these other actions separate so that it was clear what we were doing and the timing of those actions. And as you said, this is a little bit unusual for us. We've got 2 announced this year. We had the Bordeaux restructuring a couple of years ago now. And I would say when you link those together, what you're seeing is a focus on really challenging our portfolio and our manufacturing and distribution network. And that's the key driver behind all 3 of these plans.

The next question is a follow-up from Michael Polark of Wolfe Research.

One more on Life Sciences. Look, I heard the comment, Dan, one large order, $10 million, loud and clear, but it was 18% segment growth, 50% in capital, something was good. You said onshoring localization of supply chains. heard. We know that's a megatrend. I would say the feedback from bioprocessing as an example, somewhat mixed and still slow going. So I want to ask if you think there could be something else here and the other topic in tools land is the so-called self-driving labs as Claude starts doing experimentation and my joke is Claude will make the beakers dirty and someone will have to clean them. Do you see evidence that, that kind of theme is an opportunity for life sciences beyond reshoring?

Thanks, Mike. Yes, we do see that as an opportunity. Clearly, what I would say is it's not something that's registering yet in our order book or anything like that. But as that trend does continue, I think the way we produce aseptic pharmaceuticals will change over time. And I think that STERIS will be in a great position to adapt to that. So I think what we're seeing on the Life Sciences order intake and shipments as it relates to capital is just some pent-up demand, too, from a couple of years of underbuying in the pharmaceutical sector and now there's just a little bit of catch-up. So we're getting to benefit from that.

This concludes our question-and-answer session. I would like to turn the conference back over to Julie Winter for any closing remarks.

Thank you all for taking the time to join us this morning to learn more about the quarter and our outlook for the year. We do have quite a few conferences coming up this fall. I look forward to seeing many of you on the road.

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