STERIS plc (STE) Earnings Call Transcript & Summary

Good day, and welcome to STERIS' acquisition of Cantel Medical Conference Call. [Operator Instructions] Please note, today's event is being recorded. I would now like to turn the conference over to Julie Winter, Vice President of Investor Relations. Please go ahead, ma'am.

Thank you, Rocco, and good morning, everyone. On today's call from STERIS, we have Walt Rosebrough, our President and CEO; Mike Tokich, our Senior Vice President and CFO; Dan Carestio, our Chief Operating Officer; and the CEO of Cantel Medical, George Fotiades. 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 may be used. Additional information regarding these measures, including definitions, is available on today's release, also including 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 Walt.

Thank you, Julie, and good morning, everyone. It is our great pleasure to join you this morning to talk about our planned acquisition of Cantel Medical. We are excited to bring these 2 great organizations together. We've provided a PowerPoint presentation for your reference, but we will not be speaking directly from those slides. For any one new to STERIS, our mission is to help our customers create a healthier and safer world. As our mission suggests, our customers always come first, followed closely by our people. Our belief is that if we serve the needs of these 2 core customers well, our shareholders will receive superior returns over time. This has been a successful model for STERIS for over a decade. We have grown meaningfully, both organically and by acquisition, finishing last fiscal year with $3 billion in revenue and 13,000 associates around the globe. True to our customer-focused mission, over 3,000 of our people are in customer-facing sales and service roles, a significant differentiator in our business. About 3/4 of our revenue are in the United States, with the balance spread across the globe. Also, 3/4 of our business is recurring revenue, which is a combination of service and consumables. We have organized our businesses around our core customers and report 3 business segments that represent those same customer groups: our Healthcare segment generally supports health care procedural centers like hospitals and ambulatory surgery centers; our Applied Sterilization Technologies segment, or AST, generally serves medical device companies; and our Life Science segment mainly support pharmaceutical manufacturing companies. We have a nice history of successful M&A transactions focused primarily on adding products and services that either expand our relationships with these customers and/or grow our geographical reach. Now I'm sure many of you are familiar with Cantel. The business was founded in the early 1960s and has grown organically and through acquisitions to become a leader in dental and endoscopy infection prevention. We believe Cantel and STERIS are a great fit. I will now turn the call over to Cantel's CEO, George Fotiades, to provide an overview of Cantel. George?

Thank you, Walt. Good morning, everyone. It is a pleasure to join the STERIS team to announce this exciting combination. Let me take a moment to walk through why we believe this is the right transaction at the right time for Cantel. At Cantel, we are always looking to become a more dynamic partner to all of our customers across business lines and to support them with ever-improving solutions and unmatched customer service. This has been particularly true since the onset of the COVID-19 pandemic. Customers are more focused on infection prevention and control than ever before, and are looking for more innovative and complete solutions to ensure they're protecting themselves and patients. The Cantel team has been focused on rising to the challenge by executing our Cantel 2.0 strategy to develop more innovative solutions and expand the scale of our business. This combination with STERIS builds upon our strengths and it enables us to take a giant leap forward toward achieving our objectives while answering this call. Simply put, STERIS and Cantel are a perfect strategic fit. We've long admired STERIS for their track record of consistency and resiliency through market cycles and disruptions, including the COVID pandemic, which has enabled them to become one of the most trusted names in the industry. The combined companies complement each other, providing a comprehensive portfolio of infection prevention and control solutions for hospitals, ambulatory surgery centers, dental offices and life science customers. Through our Hu-Friedy and Crosstex brands, we bring dental solutions that create a complete circle of protection for dental procedures and workflow. Additionally, our long-standing relationships with dental and hygiene schools and comprehensive education and training programs are expected to provide even greater opportunities with future generations of dental professionals. We're confident we'll be able to drive broad-based adoption of our complete circle of protection solutions and enhance STERIS' existing offering with our innovative portfolio and exceptional global team. Not only do we have complementary portfolios, but our companies share a common culture built on customer-centric values. The transaction structure allows shareholders the opportunity to participate in the significant upside potential through ownership in the combined company, while also providing them with immediate cash value. With STERIS, we have the ability to accelerate our growth with the support of a stronger financial profile, greater global scale and comprehensive portfolio of leading brands. Our Board and management team are unanimously in agreement that this transaction is in the best interest of our company and all of our stakeholders. I'd like to thank our employees. This transaction is a testament to their dedication and hard work. They have risen to meet every challenge, not only navigating the pandemic, but exceeding expectations to deliver quality solutions to our customers. For Cantel employees, we expect this transaction to create growth and career development opportunities as part of a larger global organization. I'm very confident that the future is bright for STERIS and Cantel. With that, I'll turn the call back to Walt.

Thank you, George, for your comments and for being with us, if virtually, today. In terms of the strategic rationale for this transaction, the product offering, global reach, and customer set are naturally complementary to STERIS. Cantel's largest business, its medical portfolio, will add increased presence in endoscopy with a full suite of high-level disinfection chemistries, equipment and services. They will also fill gaps in our portfolio for single-use accessories in the endoscopy space. In addition, we are excited to enter the dental business, extending STERIS into a new health care procedural customer base, where there is an increasing focus on infection prevention protocols and processes. As we announced in our release this morning, we have agreed to pay a total of $4.6 billion to purchase Cantel. As this is primarily a stock deal, we would anticipate that Cantel shareholders would own approximately 15% of the combined company. We anticipate closing by the end of our first quarter of fiscal 2022. We expect the transaction to be accretive to adjusted earnings per diluted share in the first year. Similar to prior transactions, we would expect to exceed our return hurdle for IRR and to generate ROIC above our cost of capital within 3 to 5 years. Cost synergies will be crucial to getting there, and we currently believe we can generate about $110 million in annual savings within the first 4 years, with about 50% captured in the first 2 years. Synergies will primarily be created through cost reductions in redundant public company and back office overhead, commercial integration, product manufacturing and service operations. We anticipate longer-term revenue synergies as well but we are not including any in our models as they are likely to be beyond the 3- to 4-year window before they are meaningful. We expect to fund the cash portion of the transaction and repay a significant amount of Cantel's existing debt with approximately $2 billion of new debt. We have obtained fully committed bridge financing to do so. In total, we expect our debt-to-EBITDA leverage to be just over 3x following the close of this transaction, and we intend to pay that down closer to 2x in the next several years. The cash generation of our combined businesses provides us the flexibility we need to continue investing for growth. At the same time, we are paying down debt. While final decisions will not be made until closing, we would expect that our dividend philosophy and priorities for use of capital will remain the same. In closing, we are excited about this transaction. Cantel is an excellent strategic fit with STERIS. Together, we believe we can accomplish much more than either of us would alone. We will be a leading global provider of products and services that meet the needs of growth areas within health care, procedures, devices, vaccines and biologics and now dental. Combined, we will offer a broader set of customers a more diversified selection of infection prevention and procedural products and services. Based on Cantel's expectations for organic growth at the high end of our organic growth expectations, it is our belief that this transaction will allow STERIS to continue to generate mid to high single-digit revenue growth and leverage that for double-digit earnings growth over time. While this transaction will likely result in a slowdown of additional transactions in the near term, over the longer term, our plans to grow through organic initiatives and M&A are unchanged. And finally, we will continue to have a strong balance sheet and generate free cash flow that provides capacity for growth. I want to thank George and the Cantel team for being open to combining with STERIS. And I want to recognize Chuck Diker, who founded Cantel, and for his many years as Chairman, leading to this opportunity. At the time of our transaction, Chuck will join a list of distinguished entrepreneurs who successfully started businesses that make up STERIS today. From Bill Sanford and Ray Kralovic, who started STERIS; Marlin Younker, who started US Endoscopy; Gene Robinson, who founded IMS; and Richard Steeves, who founded Synergy Health. With that, Julie, would you please open this floor for Q&A?

Thank you, Walt and George, for your comments. Rocco, would you please give the instructions so we could get started on Q&A?

[Operator Instructions] Today's first question comes from Mike Matson with Needham & Company.

I guess I'll start with George. I guess first, I'm not totally surprised to see this deal. What I am a little surprised by is the fact that there is not more of a premium over where the shares closed yesterday. So I was just wondering if you could maybe address that.

Well, look, first and foremost, we -- and the Board approved this deal because we believe it's the best long-term opportunity for maximizing value. There's an opportunity here by participating in the STERIS stock for a substantial upside potential of the combined company. And of course, the immediate cash value at our 52-week high. And be mindful of the fact that yesterday, the stock was up meaningfully before this transaction was announced. And look, we -- as Walt pointed out, together, we think we can drive growth faster together than we could on our own. And we're allowing shareholders to participate in a significant upside, particularly as we unlock these synergies.

Okay. And then, I guess for the -- for STERIS folks, for Walt, my math indicates we could see double-digit EPS accretion within a few years. Does that seem reasonable and consistent with your assumptions?

Yes. Mike, this is Mike Tokich. Yes, I would agree with your statement there. We could definitely see the double-digit increases in the bottom line for STERIS as well as for the combined company.

And the next question today comes from Larry Solow with CJS Securities.

Congrats on -- it sounds like an exciting deal. Just a quick follow-up to that. I realized there was no premium to yesterday's close. Can you guys maybe discuss, have you been -- how long you've been in talks or in discussions? Has it -- this come together rather fast? Or has this been sort of a longer-term process? And is there any go-shop period or anything? Or anything surrounding that?

I'll speak first, I guess. Obviously, as we get further down the path, there'll be more disclosure in this space. But the last business flight that I took pre-COVID restrictions was March 13 to have dinner with George over this conversation. That wasn't our first conversation. So that should give you some indication.

Yes, I don't have much to add to that because he captured it exactly. Obviously, we've known STERIS a long time, a lot of admiration for the company. That's probably the best way I can answer it.

Okay. Obviously, that didn't come together overnight. Okay. Great. I appreciate it.

It came together over several years.

And our next question today comes from Larry Keusch with Raymond James.

So just a couple of questions for me. Maybe, Walt, to start, I know you touched upon this. But what about entering the dental market has you excited? Why do you think that's a good opportunity for STERIS?

Larry, great question. I wish we'd thought of it instead of them. So congratulations to the Cantel folks. But it fits exactly the model we're looking for. It's a procedural area in health care that requires infection prevention and actually is trying to up the game. So to us, it's a perfectly logical fit. Again, had we been a little brighter, we would have gotten there earlier. They beat us to it, and we congratulate them for that.

Okay. Perfect. And then, I guess 2 other quick ones for you. How we think about -- or how are you guys thinking about any FTC concerns or risks? I mean when you start to think about the AER space, you're going to have, I suspect, market share that's going to be close to 70%. And then the same thing in valves. You're going to have very strong market share when you put together the disposable valve. So how should we be thinking about FTC? And then I have one last one after that.

Yes. I don't think we agree with your analysis, Larry. And we're not expecting any divestitures at this time. Obviously, we'll file the appropriate regulatory required issues in the U.S. and Europe predominantly. But we're not seeing anything like what you are. Thanks.

Okay. Perfect. And then last one, maybe for Mike, just as we sort of just quickly do the math here, we'll obviously need to dig in a little bit more. It kind of feels like maybe mid single digit-ish returns on invested capital. A, want to get a sense of how you're thinking about it; and what are you guys assuming for your cost of capital in the deal model?

Yes. As Walt said, we believe that within the next 3 to 5 years, we will exceed both our return hurdle for IRR and generate above ROIC within those 3 years. Typically, we're looking at roughly about 10% IRR, and our cost of capital is somewhere in the 6.5% to 7.5%, maybe 8%. So we'll be within those ranges or exceed those ranges in those 3 to 5 years.

Yes. Mike -- the numbers Mike quoted are hurdle rates, not necessarily...

Correct.

The rates that we have assumed in this transaction. So we're above those hurdle rates.

And our next question today comes from Michael Cherny with Bank of America Merrill Lynch.

Hi. I'm sorry. Can you hear me now?

Yes. We can, Mike.

I apologize for that. Three things going on at once. I apologize -- to come back to the most recent comment regarding the overlap in antitrust. But maybe to ask it in a separate 2-part question. Where are the areas where you do have the highest concentration in terms of the pro forma product portfolio? And I guess in the event that you feel comfortable that there won't be any divestitures required, how does that then transition into some of the cross-sell opportunities you would hope to execute on once the deal closes?

Yes. I guess the first question is where we have the most concentration together. And it's obviously in that GI area, where Cantel is very strong relative to us. But it's -- again, that's a very broad space. We also have some minor crossover, I would say, more in the hospital and ASC outside of that space. And every place else, pretty much nonexistent.

And then...

In terms of synergies, they cross across virtually all of the operational areas of the business. So it's not necessarily sales. Clearly, we both do service, and service is more flexible in terms of what space we're in. So we think there's significant opportunity there. And geographic concentration is very useful because servicepeople spend way too much time driving as it is. And so the more we can have folks driving less and doing more service, the better off we are on the -- in the manufacturing footprint, even though we are in different product areas if you will, or different customer spaces. A lot of the manufacturing is similar. And so we think we have real opportunities in that area. And then, of course, on a percentage basis, by far, it is corporate overhead-type things, which is normal in this type of transaction.

Got it. And I guess a second question, maybe for George, but anyone can answer. So in the past, Cantel has talked about looking at some of the smaller assets to figure out the strategic fit within Life Sciences. And obviously, they've had varying levels, but typically steady performance. Does the evaluation of those assets and those pieces within the overall portfolio change now as part of the bigger STERIS entity? Or does everything as part of the deal really fit well in terms of what STERIS wants to have with the new go-to-market total product strategy?

Yes. I would say on that one -- this is Walt, sorry. I would say on that, when we work for a combination like this, there are areas that we know a lot about, and we have great deal of, I'll call it, decision capacity at the time of announcement. But we think in areas where we have less knowledge, it's a bit presumptuous of us to go in assuming something. So we will take a look at that, work on it and make the appropriate decisions about it over time. But the area where obviously we are absolutely certain about our forward situation is dental because we think it's a natural strategic fit. The other things we will look at -- we tend to like running things as opposed to selling things. So all things being equal, if you were a betting person, you would bet we end up running it. But we have divested a few things over the last 15 years, but it's a very small minority.

And the next question today comes from Chris Cooley with Stephens Inc.

Congratulations on the proposed merger. Just maybe 2 quick for me, if I may, for either or maybe Walt or Mike. Walt, maybe following on with Larry's earlier question, when you think about the dental space, can you just maybe give us some broad goal posts in terms of what you see there as growth rates? And kind of the relative margin profile for that business versus STERIS today? And then as my follow on, I'm just a little curious, you've done key surgical, you've now proposed Cantel here this morning. And it looks, obviously, to be accretive. But when I think about kind of faster-growing areas maybe out there in the broader space, help us just think about how you assessed the allocation of capital to Cantel at this time versus maybe other opportunities. Or maybe those other opportunities out there are higher valuation? I'm just kind of curious the thought process of the devotion of capital to Cantel at this time.

I guess -- so I'll go for the last question first and come back. And if Mike or George have other comments, happy to take them. But the short answer here is this is such a natural strategic fit with our business that in the short term, without question, we mentioned the operating synergies we have, which are all cost synergies. But it also then strengthens us kind of across the board in the spaces where Cantel is, and it's areas where we are generally weak. And then if you move to -- and so we just think it's an absolutely perfect fit for our business. And in the long term, our view is that creates revenue synergies in addition to those that would -- either one of us would be able to do individually. So we're very comfortable with both the growth rates, which are, in our view, at or above our current level of growth rates organically and the way it fits into our business. And all things being equal, we'll take strategic fit over a little bit of growth or a little bit of cash because in the long run, we're very comfortable that, that is more sure revenue and/or cost synergies than other areas. So at a high level, that's the -- I think the first answer. Dental is -- the second piece of this is we really do like what Cantel has done in dental. We think we've looked at it in terms of their portfolio and where their position is. And we think it's just an excellent position, and we look forward to helping grow that. And we think that's a significant opportunity for us. Not completely untapped, but we do think there's opportunity for improvement in that space. And so we're very comfortable. Again, it's procedural, it's medical, and there's a real need for infection prevention. And I think, as do the Cantel people, that it's very clear that the level of visibility to infection prevention, which we have been saying for a long time is rising, and it's rising on the bugs out running the drugs right now. And of course, coronavirus is just one example. This is not -- although this is obviously the broadest pandemic, we've had several little scares in the last decade. And we think we're going to see more and more prevention of infection across the medical spectrum, and we like the dental space that they have entered into. At a high level, that's it, Chris. We'll take culture and strategy fit as long as we're not either paying too much or super slow growth or something like that or low margins, that would be a different issue. But this fits nicely in our portfolio. I don't know, Mike or George, do you have any other comment?

Yes. Well, I'd say, look, when I talk about this being a perfect strategic fit, one of the things that makes it more perfect is the fit in dental. We -- COVID has certainly kicked the infection prevention needs up a notch considerably and for the long term. So the product portfolio that's inside of STERIS perfectly complements Cantel's. Some things in there that I think complete this circle: the chemistries, sterilants, the sterility assurance products, biological indicators. They fit great into the portfolio. This gives us an even more comprehensive portfolio. And you combine it with the people, with the feet on the street that we have in dental, on the education side and in the schools, this is really, as I said, an incredible combination of -- and why -- I think makes this a particularly natural fit for both companies.

And our next question today comes from Matthew Mishan with KeyBanc.

Congratulations on completing the deal to -- on both sides. When we look at the combination now of US Endoscopy, Key safety (sic) [ Surgical ] and Cantel, directionally, what's the combined revenue in that endoscopy area now?

There are so many pieces to that, and so -- and they sell -- in addition to endoscopy, they sell into different spaces. I don't think any of us know it off the top of our head, but it will be out there.

Okay. And just assuming that's now a much larger piece of the overall business, just kind of how do you think about endoscopy over the next 5 years and the long-term growth drivers of that business?

Sure. The -- it's very clear that endoscopy continues to grow faster than the average in our space. I think most noninvasive procedural techniques are going to grow faster than invasive -- more invasive procedural techniques. We've long enjoyed being in the endoscopy space. When we did endoscopy 8 years ago, I had to look for help on that. But when we did that 8 years ago, it was clearly our intent to do more in endoscopy. We talked about it at the time. We are very happy about Key because it adds portfolio. And then we're very, very happy about Cantel because it adds portfolio in that endoscopy space. There's still a lot of very big players in that space. We recognize that. But this gives us much more heft across the endoscopy area, and it's an area that we've always said we wanted to invest more in and we've just been fortunate to be able to do these 2 transactions recently. Key, of course, is both in endoscopy and surgery, and Cantel is in endoscopy and other spaces in the hospital. So I do not know that we've added it all up, but it's much more substantial than where we were, that's for certain.

Okay. And then Cantel had -- has had Cantel 2.0 initiatives in place for the last -- pretty much last year. Does that process continue? Or is there some pause as you assess kind of how to integrate it?

Walt, I'll be glad to answer that one.

Yes. Go ahead, please.

Look, I think this is what makes us, as I said, a perfect fit, an opportunity for us to accelerate growth. If I were to go down the list of Cantel 2.0 initiatives -- and obviously, in the interest of time, I'm going to be very brief. But we talk about the key account director program and expanding the share of wallet at -- in the health care system. Obviously, this provides us a larger footprint and bundle to take to the hospital and becoming a more important strategic partner. The surgery center is very exciting to me because they're -- obviously, it's a broader portfolio. Key Surgical is an interesting company with its inside sales model. It's a very cost-effective way of being able to reach many, many points of care and could be an interesting opportunity here. I think we've already talked about dental, what that can do to sort of accelerate the expansion of the circle of protection there. And Europe is another one we haven't spent a lot of time talking about. But the -- obviously, with the $1 billion outside the United States is a broader footprint, more scale and is a great opportunity. So to me, this incredibly accelerates Cantel 2.0 is a big part of what this value can be longer term.

Okay. And then, Walt -- yes...

Excuse me, Matt. Excuse me. George answered a piece of it, but Dan Carestio is on the line, and I think he may have a comment on the Key and Cantel space.

Yes. Can you hear me, okay?

Yes.

When you look at Key Surgical, really, because of the way they put together a series of acquisitions over the last 4 or 5 years, the endoscopy business at Key is largely European business, and the U.S. business is largely SPD-type business. And the 2 are migrating now, but it's -- I would say it's really in the early stages.

Okay. Excellent. And then last question. Walt, have you had a chance to do some diligence and further diligence on the REVOX opportunity down the road? And can that be complementary to what you guys do in AST?

Yes. This is Dan Carestio. We at STERIS have always taken a technology neutral position and have looked at many different technologies and applications as it relates to either chemical, radiation, heat, sterilization. REVOX is interesting for sure, as it's low temp, and it's something that we're going to get a lot smarter on between now and the time that the 2 companies come together officially.

[Operator Instructions] Our next question today comes from Michael Polark with Baird.

A couple of modeling ones. The tax rate, what happens as a result of this transaction? Does STERIS mix higher for the Cantel contribution? Or is there a synergy opportunity there?

Mike, there is definitely a slight synergy opportunity there just because of the way we will structure the acquisition. So a slight, slight reduction in Cantel's overall effective tax rate is what we're assuming.

So a slight reduction in Cantel's tax rate, but that rate is higher than yours...

Correct. Yes.

So maybe a little -- yes, okay, but not the full amount. Got it.

Correct.

Yes. On the debt financing, $2 billion to support the transaction. I think for Key Surgical, STERIS was able to borrow at something like 150 basis points. Have rates moved? Should we be using something that's a little bit higher to model this out? How would you frame that for us?

Yes. I think at this point in time, Mike, it's a little too early because as we look to put more permanent financing arrangements in place prior to close -- I mean we have a lot of alternatives: term loans, increasing our revolver, looking to do more private placement debt or even looking in to go to the public market. So we still have to get our arms around how we're going to permanently finance this. So it's too early for us to comment. But we will have more comment upon the close of the transaction when we finalize the permanent financing.

Last one, definitely an annoying one, but where would you expect to report Cantel in your current segment paradigm? Is this going to all layer into health care? Is there a piece that gets carved off into Life Sciences? Is there a new dental segment? Just how you're thinking about that at this early stage.

The answer is yes...

Yes.

Just as we described it, they do fit naturally. As you know, we report [ by customer ]. So they do fit naturally into those buckets. Dental does not fit naturally in those buckets so we anticipate in the additional segment.

And ladies and gentlemen, this concludes today's question-and-answer session. I'd like to turn the conference back over to Julie Winter for the final remarks.

Thanks, everybody, for taking the time to join us this morning. As always, please feel free to reach out to Investor Relations, either here at STERIS or at Cantel with any further questions.

And thank you for attending today's presentation. Ladies and gentlemen, we thank you all for your attendance. You may now disconnect your lines, and have yourself a wonderful day.