STERIS Plc (Ireland) Q2 FY2025 earnings call

Management Statement and Operational Highlights

• Total as-reported revenue grew 7% in the second quarter; constant currency organic revenue also grew 7%.
• Gross margin decreased 50 basis points to 43.7% due to labor inflation and productivity, while EBIT margin decreased 30 basis points to 22.2%.
• Net income from continuing operations in the quarter was $212.2 million, and adjusted earnings per share from continuing operations were $2.14, a 15% increase over last year.
• Capital expenditures for the first half of fiscal 2025 totaled $210 million, with depreciation and amortization at $228 million. Debt ended at $2.2 billion, and free cash flow for the first half was $344.5 million, halfway to full year guidance of ~$700 million.
• Healthcare's recurring revenue remains strong; AST's services grew 6% and bioprocessing is expected to grow in the second half; Life Sciences' consumables provided strength despite capital equipment declines.

Segment Performance

• Healthcare: Constant currency organic revenue grew 7% in the quarter, led by strong recurring revenue streams. Healthcare capital equipment revenue declined 2% in the quarter due to timing of shipments; now anticipated flat to slightly down for fiscal 2025. Margins held up with pricing, positive productivity, and lower material costs offsetting labor inflation.
• AST: Constant currency organic revenue grew 9% (6% growth in services, significant capital shipments). EBIT margins impacted by labor and energy costs, and a long-standing loss on a capital equipment order in the med-x business unit. Bioprocessing expected to grow in the second half of the fiscal year.
• Life Sciences: Constant currency organic revenue grew 3% driven by strong consumables growth. Now anticipated flat for the year with declines in capital equipment mitigated by strength in consumables. Margins benefited from favorable mix, pricing, and divestiture of the CECS business.

Guidance

• Reiterates full-year outlook: 6%-7% constant currency organic revenue growth, adjusted earnings per diluted share of $9.05 to $9.25, and free cash flow of ~$700 million.
• Life Sciences revenue now anticipated flat for the year with capital equipment declines mitigated by consumables strength.
• Healthcare now anticipated to grow mid- to high single digits with continued strength in recurring revenues.
• AST outlook is high single-digit revenue growth for the year but no longer expected to exit at double-digit revenue growth.
• Margins expected to be about flat for the year.

Risks

• Labor inflation impacting margins.
• Energy costs out of control and timing issues with passing them on.
• Ongoing litigation risks related to facilities owned in the past.

Question and Answer

Q: Maybe a couple on AST. First, just on the loss on the large equipment sale, can you frame up the magnitude of that loss, just how much of a headwind that was to margins in the segment given they were down sequentially? And then I'm curious, I think that was still included in your adjusted EPS. Was this something that was contemplated in the guidance for the year? Or is this something kind of a bad -- proverbial bad guy that you're overcoming?

A: Jacob, the impact to margins was about 200 basis points on that loss itself. And -- I mean, we had contemplated a loss, but not as large of a loss. So we were a little bit surprised by the amount. But it is a onetime event that will not recur. And it goes back to the original acquisition of Med-X back in, I think, 2020, we had taken quite a while to fulfill that order, and we had no ability to adjust the costing on that project.

Q: Just on the healthcare capital equipment updates. So I appreciate the update moving from low single-digit growth expectation to flat to slightly down. I was really just hoping if you could parse that out a little bit, maybe between progress year-to-date versus where you thought you'd be coming into the quarter? And then maybe a little bit around the backlog moving pieces and why that stepped up this quarter?

A: Yes. I mean a little bit detailed. I mean on the quarter specifically, it wasn't the best quarter for shipments. We ran into some weather-related delays and things like that with the hurricanes at the end of the quarter that did impact some shipments, especially in the Southeast. Our backlog remains incredibly strong, and we keep stacking up really strong order months on top of each other, especially in the healthcare organization. The reality is that with 6 months remaining to book and ship, we're talking about margins of 1% or 2% in one direction or the other. I wouldn't spend too much time on this in terms of -- and more importantly, we're more than offsetting it with the higher profit mix of consumables and services that's coming through.

Q: I've just got two, please. I guess on the first one, I know it's quick. But have you heard from any of your customers around supply chain changes, tariffs coming in? Do you have any expectations for how that might move things around and if there could be an effect positive or negative for you guys?

A: No, we haven't really, Patrick, and thanks for the question. But what we have seen over the last few years as it relates to the AST business, there's a lot of reshoring and front-shoring, I would say. We've seen we've seen enormous growth in our Asia Pacific region, particularly in Malaysia, where we've got a number of new builds that have come online over the last couple of years with a lot of business that has as located there as it's more of a front-shoring operation in anticipation of some challenges that might or may not occur as it relates to China.

Q: I want to ask on health care consumables and services. There's obviously a lot of stuff, a lot of products services in those two lines. And you mentioned share gains as a driver of the differentiated growth. Can you unpack that for us? What's going especially well? Can you -- is it in the processing department? Is it OR consumables? Is it repair stuff? Is it all of it? Where are you seeing differentiation in share?

A: Yes. It's all of that, to be honest with you. We've shipped an awful lot of capital equipment over the last 18 months or so. And we've really positioned ourselves nicely as it relates to some of the large IDM GPO contracts on the consumable parts, especially in sterile processing. And I think it's just that and the fact that procedure volumes are particularly strong in the U.S. that's driving consumption of our consumables business as well as our services business, which is just having a gangbuster year as well.

Q: I want to ask on AST, medtech customer trends. Dan, I think you mentioned not quite where you thought it could or should be. Do you think this is just the inventory management stuff? Or is there something else going on that you've picked up?

A: I think it's two things. I do definitely think it's inventory management. Just like STERIS has done a nice job of bringing down our inventory this year, I think a lot of our medtech customers are taking the same opportunity. And then sometimes what I've seen is the classic effect. We saw pretty strong growth in AST for end of Q4, early Q1, and then we saw a slowdown where they had maybe overproduced a bit and are keeping tight controls on inventory. Overall, what I would say is procedure rates is what drives that business. And right now, the procedure rates versus the AST growth are not matched up. And I think that as those converge, we'll see better growth out of AST. I mean all that 6% is not that disappointing. I mean let's not be overcritical here. It's just we hold that business to a very high standard.

Q: I want to start on EO. And again, apologies if you can't answer these, but I'll try anyways. Can you specify whether -- what you've disclosed in the 10-Q this morning, whether you're a codefendent or sole defendant, in those cases where you are defending against? Why not settle these cases out of court? Just maybe looking for, not necessarily your entire legal strategy, but there is risk in going to trial, of course. And then can you help us with what kind of insurance you might have against the situation?

A: Yes. Other than M&A strategy, the other thing we absolutely don't talk about is legal strategy. So I will refer you to the comments that are in the queue, and to say that we'll stay on our comments around ongoing litigation at this time.

Q: In AST, the outlook sounds like maybe a hair lower today. Is that exclusively bioprocessing related? Are there any adjustments that you're seeing or moderation, I should probably better say on pricing in that category?

A: No. It's just -- honestly, it's just the volumes that we've seen year-to-date and the trend. If we were up 1.5 points higher year-to-date, we'd be telling you no change in the AST outlook for the whole end of the year. But based on run rate, we've adjusted that to take a much more conservative approach.

Q: Just one quick one here. So with the margins now expect -- our margin at could be flat, you're still reiterating the EPS guidance. So I mean, is it just still kind of fall within that range, maybe at the lower end or something? Or is there something else going on in the P&L to offset that?

A: Yes, Mike, it does fall within the range, but we are seeing an impact or a favorable impact on interest expense. We now expect interest for the full year to be about $90 million.

Q: On the Life Sciences business, the strong consumable demand, can you flesh out kind of what you're seeing in that business? What's driving that demand? And just curious, I think there's a lot of debate around kind of what's going on with pharma demand, maybe at a higher level, kind of what are you seeing from those customers right now?

A: Yes. I would say, keep in mind, we’ve got somewhat easy comps last year. There was a lot of destocking going on in our consumables business, in particular, in the barrier products space as well as the chemistry space. And – so against those relatively easy comps, we’ve seen very strong recovery from our core customers that are back in full production.