STERIS plc (STE) Earnings Call Transcript & Summary

Good day, and welcome to the STERIS plc First Quarter 2027 Financial Results Conference Call. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [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, and I do have a few words of caution before we open the comment. . 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 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. The company does not undertake to update or revise any forward-looking statements as a result of new information, or future events or developments. There'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, adjusted operating, 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 First Quarter performance. For the first quarter, total as reported revenue grew 7%. Constant currency organic revenue grew 6% in the quarter, driven by volume as well as 190 basis points of price. Gross margin for the quarter was 46%, up 70 basis points versus the prior year. Margin expansion was driven by price and favorable productivity, which were somewhat offset by inflation. Gross tariff costs, excluding refunds, were $14 million in the first quarter. As a reminder, tariffs were $12 million in the first quarter of last year. Tariff refunds of $4 million were received in the quarter -- so on a year-over-year basis, net tariffs were favorable $2 million. For clarity, tariff refunds are not being allocated to our business segments, but instead are booked in corporate to enable business segment analysis. EBIT margin for the quarter was 23.8% of revenue, an increase of 100 basis points versus the first quarter of last year. The gross margin improvement coupled with favorable currency and operating cost discipline drove the EBIT margin expansion in the quarter. The adjusted effective tax rate in the quarter was 25.9%, an increase of 23.5% in the first quarter of last year. The year-over-year increase was driven primarily by unfavorable discrete items. Adjusted net income in the quarter was $253.4 million. Earnings per diluted share were $2.59, an 11% increase over the year. Higher margins more than offset the increase in tax expense. Capital expenditures for the quarter were $87.5 million, and depreciation and amortization totaled $123.8 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 well below our target of 2 to 2.5x. Free cash flow for the quarter was $279.6 million, down from $326.5 million in the first quarter last year. The decline in free cash was driven primarily by a lower contribution from working capital, despite improvement in net income. Share buybacks in the first quarter totaled $100 million, leaving us with $900 million under our current authorization. We also announced our 21st consecutive year of dividend increases last week with a $0.06 increase to $0.69 per quarter as we continue to prioritize dividend growth. With that, I will 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 First 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 health care. Constant currency organic revenue grew 6% for the first quarter. Our performance reflected stable underlying demand, while our commercial teams continue to drive meaningful growth across the health care segment. The strength of our portfolio continues to enable us to help our customers navigate a complex operating environment. Our service team continued its streak of outperformance, growing 10% in the first quarter. Consumables grew 9%, benefiting from increased customer consumption, driven by share gains and procedural growth in endoscopy. Healthcare capital equipment revenue increased 1% for the quarter, with growth impacted by the timing of shipments. Orders remained solid, with 4% growth in the first quarter, and our ending backlog increased to $444 million. EBIT margins for Healthcare in the quarter increased 60 basis points to 24.8% with volume, pricing, positive productivity and favorable mix, somewhat offset by inflation investments in the business and tariffs. Turning to AST. Constant currency organic revenue grew 5% for the quarter with 6% growth in services. As anticipated against difficult comparisons services volume remained light in the quarter. Global demand remains a bit soft as customers continue to manage down existing inventory. EBIT margins for AST were 48% a decrease of 60 basis points from the first quarter of last year as additional pricing was more than offset by increased depreciation and slightly lower productivity. Constant currency organic revenue increased 8% for the Life Sciences group in the quarter. Supporting that growth, capital equipment grew 17% and consumables increased 8%. Services grew 2%. Backlog at quarter end was about flat with prior year at $110 million. Margins were 42.1%, a decrease of 140 basis points as pricing and volume were more than offset by unfavorable productivity and inflation. Before we shift gears to outlook, I want to comment on the announcement we made yesterday that we will be investing $600 million to build a new formulated chemistry center of excellence in North Carolina. As noted in the release, this is our largest investment in our history in a single manufacturing site. We will be building 2 facilities totaling 600,000 square feet under roof that will include manufacturing, R&D and distribution. The facility will produce high-performance infection prevention and contamination control chemistries used by our health care and pharmaceutical customers across the globe. This investment strengthens our health care and life sciences formulated chemistries business, which together generate more than $700 million in revenue. These products are high growth, high margin and highly regulated. They play an essential role in helping our customers deliver safe, compliant outcomes for patients. This investment positions us to scale with our customers supports increasing demand and sustained growth in these strategically important portfolios over the long term. The facility is expected to become operational in 2 to 3 years in a phased approach beginning with distributions. Upon completion, we expect to transition the work from our St. Louis, Missouri and Plymouth, Minnesota chemistry manufacturing and distribution sites and closed those facilities. When finalized, the formulated chemistry center of excellence will allow us to accelerate innovation, expand capacity and optimize our U.S. chemistries manufacturing and distribution network. As a result, we announced today a restructuring program with anticipated pretax restructuring charges of approximately $55 million to $70 million, consisting of approximately $40 million to $50 million of cash expenditures and approximately $15 million to $20 million of noncash charges. We anticipate that less than $10 million will be booked in fiscal 2027. This investment will generate an ROIC of over 10% within 3 to 5 years of opening, and it is essential to our long-term growth and profitability. Shifting gears to outlook. Based on our first quarter results, our expectations for the remainder of the year, we are maintaining our original outlook for fiscal 2027. This includes as reported revenue growth of 7% to 8% and constant currency organic revenue growth of 6% to 7% for the total company. Our fiscal 2027 earnings per share outlook is also unchanged at $11.10 to $11.30 growth of 9% to 11% over fiscal 2026. While the total cost of the North Carolina facility is anticipated to be $600 million, the impact on fiscal 2027 is expected to be approximately $75 million in additional capital spending. As a result, CapEx is now anticipated to be approximately $450 million in fiscal 2027. Free cash flow is now expected to be $800 million as the strong performance in the first quarter is helping to offset the additional CapEx spend for the year. For your modeling purposes, the investment in North Carolina will spread over the next 3 years -- as of now, we expect the project to add approximately $350 million in capital spending into fiscal 2028 and the remaining $175 million in fiscal 2029. The project is in early phases of development, and we will provide additional updates on timing as they become clear. Thank you to all of our associates for continuing to do what we do best, focusing on our customers and striving to do a little better each day. Thank you, and that concludes our prepared remarks for the call. Operator, would you please give the instructions so we can begin the Q&A.

We will now begin the question-and-answer session. [Operator Instructions] The first question will come from Brett Fishbin with KeyBanc Capital Markets.

Good update today. Just wanted to ask a little bit about the underlying trends in AST service. I know you've talked about a progression in growth through the year, given the top 1 comps and inventory dynamics. But just curious like how you're still thinking about growth from here and if you still expect an uptick into 2H?

Yes. Thanks, Brett. This is Dan. Like you said, tough comps in the first half last year. We expect that to linger a bit -- but we get into easier comparisons as we started seeing destocking in Q3. We would assume we'd see acceleration at that point and the growth rates of AST. Nothing has changed in the fundamentals. But coming out of the gate last year at 13% in the first 6 months somewhat tamped down the growth right now. .

All right. Great. And then just to nitpick the other part of the business that was a little bit slower this quarter in Healthcare capital equipment. I know you mentioned timing and the backlog number looked pretty strong still. So maybe just a little bit more background on what was going on with order timing and placements and how you think that could ramp as well.

Yes. You can see our backlog swell. So it really is just a timing issue. Orders were up 4%. We are making real traction in the market right now. I'm highly confident that for the fiscal year, we're going to show solid growth for our capital equipment business. And we're reaping the benefits of the last year and half of South capital sales as you look to the pull-through that we're getting in our consumables consumable chemistries, sterility assurance and services. .

All right. And last question for me. I think I caught you might have said something about share gains in endoscopy. Maybe if you could just expand a little bit where in the portfolio you're seeing the gains.

Yes. Let me rephrase that or to clarify, we've seen higher growth in endoscopy in terms of procedural growth. And we have about 1/3 of our health care franchise is correlated to endoscopy. So that's helping us. And we are gaining share in that space. I can assure you, both in the equipment side with the automatic endoscope processors, which are driving solid growth of our chemistries or dedicated chemistries as well as the services surrounding the repair of endoscopes and different instruments. .

The next question will come from Patrick Wood with UBS.

I've got 2 questions, please. I guess the first one, I'm too brain damage to really run my head around some of the tariff stuff. But if we were to ex out both the actual refund that you guys got, but then also the expense. So to treat it like it never existed. Were underlying margins, ex all of that up? And if so, why? That's the first question. And then very quickly, second question, the $600 million deployment. That's obviously a big move for you guys. What was it that you mentioned efficiencies and distribution outside, but that's a big move. So what was it that really tilted the scales in wanting to shift of that production? .

Thanks, Patrick. I'll take the first one. I would love to not talk about tariffs as well. The gross margin is up absent tariffs, we got favorability from price, productivity. If the tariff refunds did help us offset some of that cost. It's included in the gross margin. But our true tariff costs were $14 million in the quarter. And I guess I wouldn't take those out. They're not going anywhere. .

And then Patrick, this is Dan. Thanks for the question. Relative to the chemistry expansion, if you look back when we acquired Cantel, with Cantel, they had a large chemistry manufacturing facility in Minnesota, and we have our large facility in St. Louis, Missouri. The problem is that neither are really expandable and both are going to be bumping up against the upper limits of capacity in the future. . And in order to do anything, we were going to have to do something greenfield. So once we decided that and the consolidation was eminent then we started determining what the location would be. And based on distribution efficiencies and access to talent, especially in the STEM world, we centered in on North Carolina. So this factory will be the factory of the future for us. There's going to be significant automation. It's going to look and feel like a pharmaceutical clean room. It's going to be very impressed.

The next question will come from Matt [ Talk ] with Stephens Inc. .

Maybe just to start, there's been some concern around hospital utilization rates and procedure volumes. Obviously, you posted some pretty strong growth in your health care consumables franchise. I'd love to just double tap on the performance there and what you're seeing within that end market. .

Yes. Thanks, Max. This is Dan. I'll -- we haven't seen any slowdown whatsoever and we see strong growth, especially in the ASC market. And in particular, as I mentioned before, in the area of endoscopy, which carries a lot of weight with STERIS in terms of our procedure growth impact. I understand and we are very involved in the conversation with our customers about the challenging environment that they are working in today and will work in the future as it relates to payment. But we do not see an immediate or long-term impact in terms of procedure -- and so as a result, we feel confident in the resiliency of our customers for the long term.

I appreciate that. And then maybe also, I'd love to just get a sense of what you're seeing within Life Sciences. -- onshoring is it's been talked about, but it's still on the common. I just want to get a sense of what you're hearing from potential projects in the pipeline.

Yes. It's interesting. When you think about onshoring, it's not just a move to the U.S. There's localization going on globally as tariffs become more of a play in Europe and in the U.S. And so you'll see some duplication of manufacturing sites whereas maybe in the past, you might have 1 site globally that is focusing on 1 pharmaceutical product. As a result, that's good for us because it creates need for expansion or augmentation of the manufacturing footprint which requires typically the tools, sterilizers, washers, things like that, that go into those aseptic manufacturing environments as well as it gives us more at bats and opportunities to install our chemistries into the cleaning processes. So it is happening. It's not a revolution. But any time there's disruption or change in manufacturing, generally, that's a good opportunity for us.

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