Good morning everyone and welcome to the STERIS plc Third Quarter 2024 Conference Call. Please also note today's event is being recorded. And at this time, I'd like to turn the floor over to Julie Winter, Investor Relations. Ma'am, please go ahead.

Thank you, Jamie 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 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.

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 third quarter performance. For the quarter, constant currency organic revenue increased 10% driven by volume as well as 270 basis points of price. Gross margin for the quarter increased 50 basis points compared with the prior year to 43.6%. Price more than offset continued material and labor inflation in addition to the negative impact from currency. EBIT margin decreased 80 basis points to 23.1% of revenue compared with the third quarter last year. The anticipated increase in our year-over-year incentive compensation expense, along with the mix shift in operating income from the AST segment to the Healthcare segment impacted EBIT margins. We anticipate that the mix shift in operating income from AST to Healthcare will continue in the fourth quarter. The adjusted effective tax rate in the quarter was 22.6%. Net income in the quarter was $220.9 million and adjusted earnings were $2.22 per diluted share. Capital expenditures for the first 9 months of fiscal '24 totaled $268.8 million while depreciation and amortization totaled $430.8 million. Debt declined slightly to $3.3 billion in the third quarter. Total debt-to-EBITDA at quarter end was approximately 2.2x gross leverage. Free cash flow for the first 9 months of fiscal 2024 was $457 million compared with $262.8 million for the first 9 months of fiscal 2023. The fiscal 2024 increase was driven by higher earnings and declines in cash used for tax and compensation-related payments as well as a decline in capital expenditures. With that, I will turn the call over to Dan for his remarks.

Thank you, Mike, and good morning, everyone. We appreciate you joining us to discuss our third quarter performance and our outlook for the remainder of the fiscal year. As Mike mentioned, our third quarter continued the positive trend we have seen in our Healthcare segment over the past few quarters, along with a notable improvement in Life Sciences. Overall, we are satisfied with our results. We still anticipate that our Healthcare segment will exceed our initial expectations for the fiscal year, helping to offset macro challenges affecting demand in our other segments. In terms of our segments, Healthcare constant currency organic revenue grew 12% this quarter. We achieved double-digit growth across capital equipment, consumables, and service once again, primarily due to a rebound in procedure volume in the U.S. as well as price and market share gains. As expected, our backlog continues to normalize as we are shipping faster than new orders are being placed. Our aim is to return to historical production lead times and meet customer demand. Regarding demand, capital equipment orders in the Healthcare segment also saw double-digit growth this quarter. In contrast, AST's constant currency organic revenue increased by 4%, which fell short of our expectations. While we see more normalized volumes in the U.S. medtech sector, conditions outside the U.S. are softer than we anticipated. Additionally, bioprocessing volumes are still contracting. Until we gain more clarity, we are adopting a more cautious outlook for the fourth quarter. Life Sciences experienced a 20% growth this quarter in constant currency organic revenue, with another strong quarter for capital shipments, rising 57% against relatively easy comparisons. Recall that in fiscal 2023, revenue for capital equipment and consumables was pushed from the third quarter to the fourth quarter due to supply chain issues. Consumables grew by 8% and service revenue rose by 12%. As you might hear from others in the industry, short-term demand remains somewhat uncertain, but we remain optimistic about long-term growth opportunities in this segment. Our Dental segment's third quarter revenue decreased by 6% on a constant currency organic basis, primarily due to reduced orders from a large customer facing a temporary operational disruption caused by a cybersecurity incident during the quarter. Excluding this disruption, revenue would have been roughly flat, reflecting a decline in patient volumes. The lower volume and ongoing increases in material costs contributed to a decline in EBIT margin for the quarter. Looking forward, fiscal 2024 is on track to be another strong year for STERIS, although not in the way we originally expected. Recent years have highlighted the importance of our diversified portfolio. We consistently benefit when one segment outperforms to balance challenges in others. We are updating our outlook for the year to increase revenue expectations based on the continued success of our Healthcare segment. We now expect total revenue to grow by 10% to 11% in constant currency organic terms, along with constant currency organic revenue growth of 7% to 8%, each up 100 basis points from our previous projections. This anticipates low single-digit constant currency organic revenue growth in the fourth quarter, influenced by record shipments in last year's fourth quarter. We expect EBIT margins for the fiscal year to decline slightly compared to fiscal 2023, mainly due to changes in the operating income mix from AST to Healthcare. We now anticipate adjusted earnings per diluted share to range from $8.60 to $8.70 for fiscal 2024. We acknowledge that this outlook carries a degree of conservatism, which we believe is justifiable until we observe a reduction in AST customer destocking and gain more insight into bioprocessing volumes. That wraps up our prepared remarks. Julie, please provide the instructions so we can start the Q&A.

Thank you, Mike and Dan, for your comments. Jamie, if you can give the instructions, we'll get started on Q&A.

Our first question today comes from Patrick Wood from Morgan Stanley.

You guys still run one of the most efficient earnings calls of all time. It's much appreciated. I guess maybe starting with Healthcare. As you said, double-digit growth across kind of all three of the main verticals. I'd love to unpack that a little bit. I mean within the capital equipment side, I think last quarter was sort of 65%, let's call it, sort of replacement-style projects and then roughly 1/3 kind of expansionary. Is that the same kind of thing you're seeing now? And should we expect that consumables line to remain pretty strong given the sheer amount of equipment you guys have been installing through this year if we look forward?

Yes. I'll take the consumables. Mike, if you want to take the capital. Patrick, what I would say is the consumables is a function of really two things. One is obviously, patient demand in terms of procedures. And obviously, at least in the North American markets, demand is up across the board in terms of volumes flowing through hospitals. And then the other factor on that is just the sheer number of placements that we put out there over the last year in terms of maybe a little bit of share gain.

And then on the capital side, obviously, you see that we continue to reduce our backlog levels, which is getting us more to our more normalized historic lead times and continuing to meet customer demand. But included in that, we did have double-digit orders growth within Healthcare in the third quarter. So strong shipments in the quarter but also good outlook with that double-digit growth in orders for future.

Amazing. And then maybe just quickly on AST. I guess within bioprocessing, the companies there themselves struggle to forecast their own demand, kind of famously. So I wouldn't want to necessarily put too much stock there. But the commentary seems generally more optimistic on the forward look, I would say, from some of the big players. Is that something that you think resonates with you as you move through the next few quarters, like things on the bioprocessing side get a little bit better? And then equally within AST, how far through do you think we are in that inventory burn-down given the procedure volumes have been so strong? I would have thought we don't have too long of that left. Is that fair?

Yes. We would have thought that too, Patrick. So what I would say is that we've seen the turn in the U.S. market, for the most part, in medtech destocking. And that's a function of the efficiency of the healthcare systems over here and procedure volumes being up significantly. Our customers have been able to burn down that inventory a little quicker. In Europe, where there's still a lot of fits and starts in terms of medical procedures depending on the countries, we have not seen the burn down yet in inventory. But inevitably, this can't go on forever. I mean eventually, those lines will cross. And then as it relates to the bioprocessing destocking, if we look over the long term, historically and going forward, with the exception of the blip that occurred for a couple of years during the pandemic, more than a blip to spike, it has been a very solid strong growth subset of products that we sterilize. And inevitably, I do believe that it will return to those levels of growth off of the reset number. The question is when do we get to that reset number? And as you've heard from many of our customers in their earnings and their outlook, they're taking a fairly conservative approach to the first half of the calendar year but believe that many of them will see meaningful growth in the high single digits in the second half. If that comes true, that will translate to volumes for our AST business.

Having been treated in both the U.K. and the U.S., I'm glad I live here from healthcare perspective.

Our next question comes from Brett Fishbin from KeyBanc.

Just wanted to start off with a question on some of the margin dynamics. Understand the unfavorable revenue mix shift was the primary moving piece this quarter. But just wondering if you could give a bit more color on some of the previous key moving pieces around margins like productivity and cost inflation and how those have progressed into the back half?

Yes, Brett. One area we've been focusing on all year is the gap in incentive compensation that needed to be addressed, which amounted to approximately $40 million in challenges. Most of that, around $22 million, was felt in the third quarter, creating a significant gap we needed to bridge. On a more positive note, we have seen prices for the first time actually offset labor inflation, and we recorded flat productivity. Previously, we experienced negative productivity as we worked on moving products, particularly capital equipment, which required multiple touches before they could be shipped out in our manufacturing process. Recently, we've observed a notable improvement in productivity. Last quarter, productivity was approximately negative 150 to 200 basis points, but it has stabilized this quarter. This positive development indicates that our supply chain is continuing to improve, effectively reducing our backlog and returning to more typical lead times.

All right. Great. And then just one other follow-up, a little bit of a longer-term question around AST. Just wondering if you could provide a bit of an update around your progress in adding more X-ray sterilization capacity as an alternative modality across your network. If I'm not mistaken, you have a couple of locations already up and running. And I think there are some additional ones that might come online in the next few years. So just any additional details would be great.

Yes, sure. This is Dan. The two of the U.S. sites will come online this calendar year. That's in Chicago, Libertyville, Illinois area that is in testing phase now and should be running product in the next few months. And then the second one that will come online will be California, Ontario, California and that will be in the fall.

And then outside of the U.S., we have several projects underway.

We have the Asian site coming online now, and I can't recall the exact timeline for a few of the European sites, but several of them will be operational in the next 18 months.

Our next question comes from Jacob Johnson from Stephens.

Maybe just one on margins to start. Just on AST margins, I think they declined sequentially on a similar revenue base. What was that mix? Was that incentive comp? Just anything you'd call out there? And any thoughts on how we should think about that into the fourth quarter?

A general comment, Mike, I'll let you add to it. We typically see some decline in the third quarter due to the holidays. There are often fewer billing days because customers frequently have shutdowns over Thanksgiving and between Christmas and New Year. Unless we have a backlog in the factories, we usually lose some time during this period. Consequently, it affects the margin. However, this is a normal trend we observe from the second quarter to the third quarter. There have been a few instances in history where we did not follow this trend, such as when bioprocessing volumes were exceptionally high or we needed to manage a backlog. Generally speaking, you can expect this to occur, and it may be somewhat amplified by the fact that we experienced lower than expected volume in the European plants.

And we did have some cobalt loadings where we actually took our plants off of line for the quarter. I think we had six or eight cobalt loading. So that also hurt from a productivity standpoint which negatively impacted margins, yes.

Got it. And then just maybe as a follow-up on the Life Sciences segment, obviously, strong performance. Dan, it seems like from your comments, some of that was just easy comps but you also kind of struck some positive tone around the longer-term outlook there. I'm just curious kind of what you're seeing in terms of demand there as it relates to aseptic manufacturing clients because that's been in focus somewhat this week?

It's interesting. In the Life Science division, when we generate revenue from shipped products, that becomes a major point of concern for us, since many of these orders are placed a year ahead of time. As you mentioned, our comparisons to last year's third quarter in terms of shipments were quite favorable. Additionally, we experienced a strong fourth quarter. I think those factors play a role here. Although we're not ready to make any definitive long-term predictions about aseptic manufacturing demand, we have a positive long-term outlook. However, in the short term, there's still some inventory reduction happening and ongoing pressures in the pharmaceutical industry. Overall, though, we anticipate that the demand for aseptic drugs, injectables, biologics, and therapies related to cell and gene will be substantial, along with the corresponding sterilization products and services we provide.

Our next question comes from Michael Polark from Wolfe Research.

It might be early, but I'm interested in your thoughts as we approach fiscal '25. After reviewing the model last night, I see a potential for 6% organic revenue growth, possibly a bit more depending on AST and STERIS's historical EBIT margin, which could expand by 30 to 50 basis points, and that seems reasonable for now. As you prepare for next year, do you believe the current environment supports a return to the usual STERIS growth strategy? Or do you have a different perspective at this early stage?

Mike, your opening comment it's a bit too early for us to comment at this point in time. You answered your own question there a little bit. Obviously, we're in the middle of our planning process. We will, as we typically do, provide FY '25 guidance in May on our full year fourth quarter call. So that's where we stand right now.

I want to ask about AST, which I see as a two-part question. Clearly, procedures are returning, and it seems that medtech is performing well overall. You mentioned that the situation in the U.S. is positive, but it's still somewhat uncertain outside the U.S. Is there any specific COVID-related product category still impacting this, like PPE? Or is it simply that the recovery of procedures in Europe is more cautious?

That's it. It's specific to Europe, too, because we've seen pretty decent recovery in our Asia Pacific plants. So this is a predominantly European demand issue that's just well, not necessarily demand, it's ability to deliver healthcare issue that's taking longer to burn down inventories.

The second piece concerns large interventional multinational medtechs, such as those involved in hips, knees, stents, and pacers. Are these customers indicating that they may have an excess inventory and need to slow down their ordering, or are you not hearing that at all?

That's the communication we've received from customers. Many have indicated that they are reducing inventory by as much as 40% from their current levels. This situation stems from the pandemic and post-pandemic impacts, which caused inventory levels in supply chains, manufacturing, and raw materials to become quite excessive due to concerns about supply reliability. Additionally, a decrease in production rates has made it take longer to reduce these inventories in Europe.

And our next question is from Jason Bednar from Piper Sandler.

I'll start first, following up maybe on some of the prior questions on segment margins. I was going to take a stab at fiscal '25 but Mike already tried that. So I'll go a different route. It sounds on the margin side, like you're not too worried about the AST profit level. We saw third quarter as the seasonal low point. But is there anything structural keeping us from getting back to the upper 40% margin levels we saw in fiscal '22 and the first part of '23? Or are those just tough to match given the volume lift you were seeing at the time? And then similar question but on the other side, in Healthcare, how sustainable do you see segment margins in that segment? I think it hit a new high this quarter. Is the strength there simply a function of the consumables and equipment volumes you're seeing? Or is there any kind of uplift that's coming from the assets you acquired from BD.

On the AST side, it's all volume, Jason. This is a very high fixed cost base segment. The more volume we put through, the better opportunity we have to drive increased EBIT margin. So there, it's all volume. Dan, do you want to address Healthcare.

Yes. No, I don't see any fundamental changes really in Healthcare. It's that, once again, as long as our delivery rates stay up high, it should be fairly consistent, plus or minus a bit different to one way or another from quarter-to-quarter.

And BD is slightly incremental, Mike.

Okay. I don't want to lead either of you but it sounds like Mike, you're saying nothing structural from getting from tariffs getting back to the upper 40s in AST. And Dan, you're saying nothing structural that would keep you from maintaining the margin level you're at right now in Healthcare.

Yes. Correct.

Okay. All right, great. And then over on Dental, I'm sorry, I probably have asked this a few different times now in consecutive calls, you've been reviewing internally the future plans for the asset. This was a weak quarter, part of that out of your control, you had Henry Schein cybersecurity attack. But I guess maybe two questions on those items. Can you say first, whether near-term trends have normalized following that cybersecurity attack and the kind of the resolution we've seen with that business and that issue? And then can you talk about the conversations you're having regarding the future for this segment, do you have a timeline on when you'll announce the formal decision here?

Yes. I guess on the first, we have seen things normalize in terms of regular order base and whatnot. The challenge is a lot of that revenue kind of evaporated and get shifted into Q4 is at least is what we anticipate to some degree or found other venues to get to the customer, which we don't really have the ability to track or fully understand. So we'll see what the outcome is of that more definitively this quarter. On the other question, we continue to look at the portfolio in general but no decisions have been made at this point. And as soon as we have something to update you and everyone else with on this matter, we will do so.

Our next question comes from Mike Matson from Needham & Company.

I just want to ask one on use of cash. So I think you've done a fair bit of M&A. I don't recall any recent share repurchases but maybe I'm forgetting one. But can you maybe just give us an update on your kind of priorities and whether or not you'd be willing to kind of come in and do some share repurchasing?

Yes, Mike, our process for capital allocation has remained consistent over the past decade. Last year, in the fourth quarter, we took advantage of an opportunity to repurchase shares, acquiring about $225 million worth. However, we have not made any purchases in fiscal year 2024 so far. Our current focus has shifted more towards paying down debt due to higher rates, as we believe reducing debt is valuable. Consequently, all of our excess cash has been directed toward debt repayment, which has maintained our leverage ratio at 2.2 times gross leverage, even with the BD acquisition. This has been our priority.

Okay, got it. And then, I believe you've been able to get a little more pricing in recent periods. How sustainable do you think that rate of price increases as we see inflation kind of slowing down here a bit?

Yes, I think that to some extent, our ability to justify putting through price increases with customers has to be some basis of cost. And as costs can normalize in certain areas, there will be a market trend towards less price grabbing, I guess, what I would say.

Okay. And then finally, the last one on the outlook for tax rate with Pillar Two. I mean your rate is kind of well above that 15% level. But do you expect any sort of impact there to your tax rate?

Mike, nothing material from Pillar Two, if and when it does get implemented.

Our next question comes from Dave Turkaly from JMP Securities.

Bouncing around a bit, you may have talked about this but I wanted to just ask quickly. Any update on that radiation sterilization master pilot program, like in terms of participation or anything we should assume. Anything you've learned or anything you think we could look at in terms of how that might impact things moving forward?

Yes, Dave, this is Dan. The response from customers and regulators, including the FDA, has been very positive regarding the program. We are excited about it as it creates a lower regulatory and switching barrier for our customers, allowing for more supply chain flexibility when switching between different sterilization methods. We believe it was important to provide this option to the industry and collaborate with the FDA for its approval, especially during a time when many faced challenges. There is no significant short-term impact expected, but we anticipate that, in the long run, this program will be beneficial for us and advantageous for our customers.

As a follow-up, when considering EO, is the margin profile significantly different between the various sterilization modes they might switch to?

Not really, no.

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

Healthcare capital is something I’m reviewing the latest numbers on. I'm aware that you have customers who are eager for product and you want to ensure quick shipments. However, I perceive the potential for a soft landing for Healthcare capital revenue in 2025. There was concern that it might decrease as lead times and conversion rates improve. Yet, I envision a scenario where growth slows, but if orders remain steady at the current levels, Healthcare capital revenue could still grow in fiscal 2025. Although you don't provide guidance, I'm interested in your thoughts on this theory.

I love your theory and I hope it plays out that way.

Okay. I had one other follow-up. Cobalt 60, I heard the comments on maybe a little bit of downtime from loading and we obviously know that Nordion was exceptionally calendar 4Q weighted in terms of deliveries in calendar '23. Is there some element that now that you're back to like full strength at those plants, the gamma network speeds up in the short run? I'm just curious how that actually works.

It does, but the issue is the volume. We've had to take the cobalt because many of those plants have been in a deficit position, with some not loading for over a year. However, it should not have a significant impact unless we receive more volume than expected. If we do, we'll be able to operate efficiently since we'll have increased capacity.

And ladies and gentlemen, with that, we'll be ending today's question-and-answer session. I'd like to turn the floor back over to management for any closing remarks.

Thanks, Jamie and thanks, everybody, for taking the time to join us this morning. We look forward to catching up with many of you in the coming weeks.

And ladies and gentlemen, with that we will conclude today's conference call and presentation. We thank you for joining. You may now disconnect your lines.