STERIS plc

NYSE:STE

Earnings Call Analysis

Strong Start and Positive Outlook for Fiscal Year 2025

STERIS began fiscal year 2025 with an impressive 8% revenue growth driven by a 6% organic increase. Despite some cost challenges, such as increased compensation and higher insurance costs, gross margin improved to 45.1%. The company saw a substantial 10% rise in adjusted earnings per share to $2.03. They also reduced debt to $2.3 billion post-dental divestiture. Looking forward, STERIS maintains its guidance of 6-7% revenue growth and adjusted earnings per share of $9.05 to $9.25. Free cash flow is predicted to be about $700 million with capital spending of approximately $360 million. STERIS remains confident in its ability to meet its full-year targets.

Strong Start to the Fiscal Year

The company kicked off the fiscal year robustly with 8% total revenue growth in the first quarter, as highlighted by CFO Mike Tokich. Much of this growth was fueled by a 6% increase in constant currency organic revenue, driven primarily by volume and a 270 basis points price increase. Despite inflationary pressures, the gross margin improved by 30 basis points year-over-year, reaching 45.1%. However, increased compensation and insurance costs negatively impacted the EBIT margin, which decreased by 20 basis points to 22.3%.

Healthcare Segment Performance

The Healthcare segment saw a 5% growth in constant currency organic revenue during the quarter, driven by increasing procedure volumes in the U.S., price hikes, and market share gains. Although capital equipment revenue in Healthcare faced a decline due to challenging comparisons, expectations remain positive with anticipated low single-digit growth for the full fiscal year. Over half of the company's consumables and service revenue is independent of capital equipment shipments, adding resilience to this segment.

Advanced Sterilization Products (AST) and Life Sciences

The AST segment exhibited its best performance in over a year with an 8% growth in constant currency organic revenue. Growth was bolstered by gains in the European Medtech market, despite bioprocessing revenue remaining flat year-over-year. Life Sciences experienced a 4% growth in constant currency organic revenue, thanks to strong consumables sales. The sector's reported revenues were impacted by the divestiture of the CECS business on April 1.

Financial Health and Guidance

Net income for the quarter reached $201.7 million, translating to an adjusted earnings per share of $2.03, a 10% increase compared to last year. The company paid down debt to $2.3 billion following the dental business divestiture, achieving a total debt-to-EBITDA ratio of approximately 1.6x. Free cash flow for the quarter amounted to $195.7 million, influenced by the timing of capital expenditures, which increased year-over-year to $108 million. Furthermore, the company announced its 19th consecutive year of dividend increases, raising the quarterly dividend by $0.05 to $0.57 per share.

Outlook and Full-Year Expectations

For the full fiscal year, the company maintains its guidance of 6% to 7% constant currency organic revenue growth, with adjusted earnings per share expected to range between $9.05 and $9.25. Free cash flow projections are steady at about $700 million, with anticipated capital spending of approximately $360 million. The management expressed confidence in meeting these expectations, driven by positive trends in all segments.

Challenges and Strategic Initiatives

The company is actively addressing challenges such as increased labor compensation and insurance costs, which have pressured margins. Plans are in place to manage these costs effectively over the fiscal year. Additionally, the restructuring plan announced last quarter, involving the closure of a manufacturing facility, is expected to yield a $25 million benefit in FY25, with greater benefits anticipated in FY26.

Q&A Insights

During the Q&A, executives acknowledged a broken model due to an unusual backlog and large project orders over the last 18 months. They emphasized their confidence in achieving revenue growth even with a lower backlog, thanks to improved manufacturing and supply chain conditions. They also indicated confidence in their Healthcare segment despite analyst skepticism about the low single-digit guidance for capital equipment revenue growth.

Earnings Call Transcript 2025-Q1

[Operator]

Good morning, and welcome to the STERIS First Quarter of 2025 Earnings Call. [Operator Instructions] Also please be aware that today's call is being recorded.

I would like to now turn the call over to Julie Winter of Investor Relations. Please go ahead.

[Julie Winter, executive]

Thank you, Joe, and good morning, everyone. As usual, speaking on today's call will be Mike Tokich, 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. 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. 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 in our press 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 Mike.

[Michael Tokich, executive]

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. Our discussions today will be focused on results from continuing operations. As you saw in the press release, we started the year strong with total revenue growth of 8% in the quarter. Constant currency organic revenue growth of 6% driven by volume as well as 270 basis points of price. Gross margin for the quarter increased 30 basis points compared with the prior year to 45.1%. Positive price and favorable material costs were somewhat offset by inflation. EBIT margin decreased 20 basis points to 22.3% of revenue compared with the first quarter last year, increased compensation and higher insurance costs are impacting EBIT margins. The adjusted effective tax rate in the quarter was 21.3%, lower than the prior year due to favorable discrete item adjustments.

Net income in the quarter was $201.7 million and adjusted earnings per share was $2.03, a 10% increase over last year. Capital expenditures for the first quarter of fiscal 2025 totaled $108 million, and depreciation and amortization totaled $112.7 million. Capital expenditures were higher year-over-year, mainly due to timing. With the closing of the dental divestiture on May 31, we were able to pay down debt, reducing total debt to $2.3 billion. Total debt to EBITDA at quarter end was approximately 1.6x gross leverage. Free cash flow for the first quarter was $195.7 million. Free cash flow was impacted by the timing of capital spending. Last week, we announced our 19th consecutive year of dividend increases. Our quarterly dividend increased $0.05 per share from $0.52 to $0.57.

With that, I will turn the call over to Dan.

[Daniel Carestio, executive]

Thanks, Mike, and good morning, everyone. Thank you for joining us to hear more about our first quarter performance and our outlook for the rest of the fiscal year. As you heard from Mike, we had a strong start to our new fiscal year. Looking at our segments, healthcare constant currency organic revenue grew 5% in the quarter. Our outperformance in consumables and services continues to be driven by procedure volumes in the U.S. as well as price and market share gains. It is our expectation that recurring revenue will continue to grow above procedure volumes and relatively independent of our capital equipment shipments. Over half of our consumables and service revenue is not related to our capital equipment.

As anticipated, our Healthcare capital equipment revenue declined in the quarter against challenging comparisons. However, we still anticipate low single-digit revenue growth for Healthcare capital equipment for the full fiscal year. We remain confident in our expectations of a strong year for our Healthcare segment.

Turning to AST. Constant currency organic revenue grew 8%, the best performance we have seen in over a year. Supporting that growth, Europe Medtech grew nicely in the quarter, and bioprocessing was about flat year-over-year globally. We are pleased to see these 2 factors playing out as planned and continue to anticipate a return to growth in bioprocessing revenue in the second half of our fiscal year. Constant currency organic revenue growth for Life Sciences was 4% in the quarter, driven by strong growth in consumables. As expected, the divestiture of the CECS business on April 1 impacted our as-reported revenues.

For the full year, we are reiterating our outlook, including 6% to 7% constant currency organic revenue growth and adjusted earnings per diluted share of $9.05 to $9.25. Our expectations for free cash flow also unchanged at about $700 million with approximately $360 million in capital spending. All in, we are pleased with the start of the fiscal year. Trends continue to head in a positive direction for all of our segments and we are confident in our ability to deliver on our full year guidance.

That concludes the prepared remarks for the call. Julie, would you please give the instructions so that we can begin the Q&A.

[Julie Winter, executive]

Thank you, Mike and Dan, for your comments. Joe, can you please give the instructions for Q&A and we can get started.

[Operator]

[Operator Instructions] And our first question of today will come from Brett Fishbin with KeyBanc.

[Brett Fishbin, analyst]

Just wanted to start off on Healthcare capital equipment. I'll repeat my question a little bit since it sounds like you already kept kind of the directional low single-digit guidance for the year. I'm just curious how the first quarter compared versus maybe your internal expectations? And then what drives the step-up in trends through the year?

[Daniel Carestio, executive]

Yes. I would say that it was right in line with our expectations. There's always orders that ship and slip one way or another in terms of our general outlook for the year remains unchanged. And typically, with last year being the exception, Q1 is our slowest quarter in capital shipments. It's a new year in terms of sales and sales commissioning, and it generally is our lowest quarter. But tough comps to last year as we were still pushing through an enormous backlog as a result of some supply chain and manufacturing challenges that we were having in the comps.

[Brett Fishbin, analyst]

And then just on the rest of the Healthcare segment, it was really nice to see some of the double-digit growth trends continue in services and consumables more than offset at least for our model, the miss in capital equipment. I mean you mentioned market share gains, healthy market activity. Is there anything else that you would call out just driving the continued strength that we've seen in either of those segments?

[Daniel Carestio, executive]

We reiterate the fact that most of those products and services that are consumables are reoccurring in nature or procedural driven. And as we've seen the continued rise in sustained growth of procedures, in particular, in the North American market. We've been lifted in that area by market in general. But as you're well aware, we've punched above our weight for the last couple of years in capital sales. So having those new placements out there, having that access from a sales perspective has helped fuel our ability to take a little share as part of our total enterprise solution selling process, where we're really working with the large IDNs and large health care systems to take the full value of STERIS.

[Brett Fishbin, analyst]

All right. Got it. And last question for me. Just touching on operating margin. I know 1Q is sometimes a little bit seasonally lower, but just given that it was down 20 bps year-over-year. I'm curious if you could give a little bit more color you touched on a couple of the high-level drivers there. And then if you still expect to demonstrate a level of year-over-year operating margin expansion for the full year FY '25?

[Michael Tokich, executive]

Yes, certainly, Brett. Yes. As I spoke with my comments, we definitely did have some increased compensation year-over-year in Q1, which negatively impacted our margins. And we did have significantly higher insurance costs in the quarter. Everybody looks at EBIT margin. I mean if you look at EBIT dollars, EBIT dollars were up $20 million. So obviously, we're not getting the leverage that we anticipate. But it's Q1, we still anticipate that we will drive positive EBIT margin leverage for the full year as we talked about last quarter.

[Operator]

And our next question will come from Mike Matson with Needham & Company.

[Michael Matson, analyst]

Yes. Just following up on the commentary there around inflation. So it sounds like the -- while the material side, materials components has kind of improved the labor side is still seeing some pressure. Is that right? And do you expect that to get better this year? I mean we've seen the unemployment rate starting to tick up? Or is it still really kind of battle out there to hire and routine employees.

[Daniel Carestio, executive]

Yes. I would say this, I mean, the thing with the compensation and labor is, it tends to go in place months before you feel the effect of it. It's because it sort of rolls in aggregate. I don't believe it's going to continue to go up in any meaningful way. And clearly, our ability to staff and turnover has come down quite a bit. So it feels like it's very much in control. It's just -- it's catching up with the labor rates that have been put in place over the last 6, 9 months, 12 months as they roll into this new fiscal year.

[Michael Matson, analyst]

Yes. Okay. Got it. And then just in the -- I wanted to get an update on the Life Sciences business as a medical device analyst that I think, I don't know as much about or follow us closely. It looks like it's been a little slower. Just wondering kind of what the outlook is there and what you're seeing in the market.

[Daniel Carestio, executive]

Yes. We've definitely seen some slowdown in demand for capital products, and that's a result of some of the decreased funding and some of the cutbacks that we've seen in general pharma and biopharma over the last 6, 9 months and there is some natural cyclicality to those purchases. However, having said that, we're showing strong growth in our services businesses and have been and more importantly, in our consumables business, which drives a disproportionate amount of the income through the Life Science segment. So we feel confident in our ability to continue to deliver on those aspects.

[Operator]

And our next question will come from Michael Polark with Wolfe Research.

[Michael Polark, analyst]

I hate to harp on this, but the Healthcare capital equipment guidance of low single-digit revenue growth this year, I still struggle to get there given where 1Q landed and what we see out of the backlog. I suspect, over the last 90 days or so, you've heard this feedback. And I'm interested in your feedback, to the feedback. Like what are we all missing in our models, why and you could call me a bad analyst and bad model or that is fair. But like I just -- I struggle to get there. So is it that you expect bookings to be a lot higher, the rest of this year versus what we've been seeing in dollar terms? Any more color there, I'd appreciate it.

[Daniel Carestio, executive]

Mike, I don't think you're a bad analyst or a bad model or by any means. The problem is the model got broken over the last 18 months in terms of how it normally has operated historically. And we ended up having a lot of backlog and a lot of large project orders. What we have now, now that manufacturing and supply chain is back in control and back to normal lead time levels is the ability to sell a lot more on the turn business, which is something we weren't really able to do over the last 18, 24 months where we were much more challenged. So we're confident in our ability, even with a lower backlog to be able to turn product and get it installed in our customers by the end of the fiscal year. .

[Michael Polark, analyst]

Appreciate that. A follow-up on AST. Obviously, you see kind of a continuation of the higher growth rate here. I heard positive comments out of Europe. As you look forward to the rest of this fiscal year, are capacity expansions -- and you've obviously been investing a lot of growth dollars here to expand your fleet and network. Are capacity expansions expected to be differentiated growth contributor here to AST over the next year or so? Or would you say that bid as normal relative to the last few years?

[Daniel Carestio, executive]

I would say it's normal. It's a long-term play, and it's -- you can't really look at the expansions as same-store versus new store because most of our expansions are on existing sites of adding just existing or adding new capacity to existing sites. So we see it a continuation to facilitate the growth that we've had historically.

[Operator]

And our next question will come from Jacob Johnson with Stephens.

[Steven Etoch, analyst]

This is Mac on for Jacob. Just following up on the Life Sciences side of the business, I'd like to question here. I think this is important tied to injectable drug demand, and we are seeing a number of capacity additions in this end market. In the near term, I know there are some headwinds that you called out around capital spending, but are you seeing any green shoots in the injectable market at this point?

[Daniel Carestio, executive]

We are. It's definitely a bit of a tailwind that's offsetting some of the headwinds in the space, I guess, is what we'd say. And fortunate thing about the injectables, that's obviously in our sweet spot of aseptic manufacturing and definitely feeds well into our chemistries and critical environments products as well as barrier product solutions. So it's -- and it's from fortunately, some of the majors as it relates to major manufacturing customers of which we do business with many of them. .

[Steven Etoch, analyst]

And then you'd previously announced some supply chain initiatives. I think you're working on moving to some larger suppliers. How is that going? And do you expect any margin impact and looking forward?

[Daniel Carestio, executive]

Yes, but it's a long-term play. It's going to take time to ring that out and to vet those suppliers and get everything in place. Yes, the long-term play is to over time and also getting better scale and value out of our manufacturing operations. But really, the most important thing is the surety of supply. If there's 1 thing we learned 1 year, 1.5 years, 2 years ago was making sure that we were with the right suppliers.

[Operator]

[Operator Instructions] Our next question will come from Jason Bednar with Piper Sandler.

[Jason Bednar, analyst]

Apologies upfront here. I'm going to come back to this Healthcare equipment topic. I know you don't provide exact numbers on orders, but I think all of us back into your order book based on the revenue and the backlog figures that you do provide. So I guess I'm wondering if we can go 1 step further beyond the Healthcare equipment revenue guidance of low single digits. Can you remind us or help us with what your assumptions might be for order growth this year? And are you anticipating Healthcare backlog to move higher or lower from where we are at the end of the first quarter?

[Michael Tokich, executive]

Yes, I would say that in our assumptions, the order growth would be mid-single digits, and we would have backlog somewhere in that $350 million range, but it could be lower than that easily. That is just a target that we have. But the big thing that we really need to do, as Dan spoke earlier about, is really have the opportunity to get and tackle the turn business that we did not have the ability to do that with our lead times coming down significantly, that's really the driver. And that's something that you guys really can't see what we're doing and how we're doing it. And as Dan said, the model has been broken. And obviously, we're doing everything we possibly can to get back to more sustainable model that we were used to and when capital equipment wasn't such a large conversation in the past, right?

[Jason Bednar, analyst]

Okay. That's helpful, Mike. And then just maybe a couple of follow-up modeling questions for you. And sorry, if I missed it, just the -- I think you said there were some discrete items in that interest other line. That was just a notable delta versus our model. Just were these factored into the original guide and any other detail you can provide there. And then the 21% tax rate in the period, is that the right level we should be thinking about on a go-forward basis? Or were there one-timers that pushed that rate lower than you expected in the first quarter?

[Michael Tokich, executive]

Yes. On the tax rate, there were some favorable discrete item adjustments that were one-timers that definitely pushed the rate lower. I think our full year guidance still calls for 23% full year rate. I would stick with that at this point in time. And we did pick up a little bit of benefit on the interest line year-over-year as we were able to use the proceeds from the dental sale much more quickly than we anticipated. So we got a little bit of favorable benefit. But again, those are pennies here and there. It doesn't really change our full year outlook.

[Operator]

And our next question will come from Dave Turkaly with JMP Securities.

[David Turkaly, analyst]

Just where we look at the BD ad that you guys did, does that sit primarily in consumables in the Healthcare business like from a mix standpoint? And I think you said it was similar margin to your core, but I just wanted to reconfirm that.

[Daniel Carestio, executive]

Yes, on both. It is classified as consumables in our healthcare mix.

[Julie Winter, executive]

90%, Dave, is in consumables in the last time that containers that are in the capital bucket.

[Daniel Carestio, executive]

Yes.

[David Turkaly, analyst]

And then I think you have a restructuring plan underway. And I don't recall exactly the size or the timing. But any detail on that?

[Michael Tokich, executive]

Yes. We had announced last quarter that we had a $100 million restructuring plan. The bulk of that was for a closure of 1 of our manufacturing facilities. That will continue to occur throughout this year. We've got about a $25 million benefit coming from that, but the bulk of that benefit will happen in fiscal year '26, not in '25.

[David Turkaly, analyst]

Great. And last one, and I saw the increase in the dividend, obviously, 19 years is a pretty good track record. But as you look at M&A and share repo, I guess, some other capital priorities, anything changed on that front given what we're seeing out there and maybe even the valuation of some of the smaller peers in the space?

[Daniel Carestio, executive]

No. I mean our investment priorities remain the same, and we don't really talk about forward-looking M&A. But we have a history of being active and obviously, we're in a good position in terms of debt. And if opportunities present themselves over the coming years, we will obviously do what we normally do.

[Operator]

And our next question is a follow-up from Michael Polark with Wolfe Research.

[Michael Polark, analyst]

Just 1 more, please, for the model. The interest in other line, I heard the discrete items called out in the quarter. What is a good number with your pro forma balance sheet now for that line on a quarterly basis for the rest of this year?

[Michael Tokich, executive]

On a quarterly basis, I don't have that in front of me, but for a full year basis, we're still looking at about $100 million in total.

[Michael Polark, analyst]

Okay. I'll -- we can take that offline. I appreciate it.

[Michael Tokich, executive]

I just don't have it in front of me, Mike.

[Operator]

And with that, that will conclude our question-and-answer session. I'd like to turn the conference back over to Julie Winter for any closing remarks.

[Julie Winter, executive]

Thanks, everybody, for taking the time to join us this morning. Look forward to catching up with many of you in the coming days.

[Operator]

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