STERIS plc (STE) Earnings Call Transcript & Summary

Thank you, everyone, for joining today. My name is Sarin, and I'm an associate here on the medtech team at JPMorgan. It's my pleasure here to have on the call today STERIS' CEO, Walter Rosebrough. [Operator Instructions] And with that, I'd just like to hand it over to STERIS to start out with some introductory comments.

Good morning, everyone. It's great to be with you again. I know we often complain about the crowds and the hustle and bustle at this conference every year. I think we'll all be looking forward to being back next year in the crowds and hustle and bustle instead of virtual as we are today. But it's great to be back at JPMorgan, and we appreciate, Sarin, you putting us on and working with us. Also for my California compatriots, I apologize for waking you up at 4:00 this morning to see this discussion, but really appreciate you joining in for any of you out West. Today, we are going to change the program a bit from what the original intention of the program was. As most of you know, we announced a significant acquisition yesterday morning. So instead of going through the presentation that we would have gone through, I'm going to give an abridged version of that conversation and then an abridged version of the conversation we had yesterday morning with -- in the announcement of the Cantel acquisition and then try to leave maybe more than a little bit of time, more than normal time, for Q&A. With that, I will remind you that the presentation you have in front of you has -- the beginning of it is the cautionary statements that relate to that presentation. The presentation that discusses the merger of Cantel and STERIS is on our website in the IR section. Again, it has the appropriate cautionary statements. We will not be showing any of those slides today. And for those of you who are looking at the PowerPoint slides as we go through this, I only intend to use Page 4, 5 and 12 in this conversation. With that bit of housekeeping behind us, turning to Page 4. For those of you who don't know STERIS well, we're a $3 billion company, about 13,000 people, New York Stock Exchange. Turning to Slide 5, it lays out our segments which also happens to be our customer sets. We are a very customer-focused organization. We literally organize our business around our customers. And as a result, our reporting segments are also organized around our customers. Our 3 customer sets, the largest business, about 2/3 of STERIS, is in the -- we call it the Healthcare space. You really should think of it as the hospital and other procedural centers like ambulatory surgery centers, for example, where procedures are done in health care. That makes up about 2/3 of our business. The next largest piece of our business, about 2/3 of the balance, so about 20% of the business, is this customer set or medical device companies. And we sterilize their devices for them, single-use devices that require sterility. We sterilize their devices in large quantities and then move them on to their distribution chain. And then the smaller segment in our business is what we call Life Science. By the way, we call the previous one AST. But we call Life Science, this is the smallest of our businesses. And that business relates, again, to sterilization, cleaning of pharmaceutical facilities and, again, working with large pharma customers strictly around vaccines and biologics. All 3 of those segments are nicely growing. And all 3 of those segments, if you think of the core of the segment, it's really around those places that need to be sterile or disinfected. And so the product sets around those cores relate to that in health care, predominantly in surgery and also in the central sterile department, which supports surgery as well as other areas where procedures are done that require sterility or cleanliness. A classic example is in the GI suite. We're unusual in the health care space in that we do both capital goods, single-use disposables, particularly in the endoscopy space, as well as provide a broad array of service in that space. We have roughly 3,000 people around the globe who are customer facing in those 3 spaces that I described, our Healthcare, Life Science and AST space. And that is really an advantage that we have in this business. I think I'll move on because I think most of you know a great deal about STERIS. So I would move to the Slide 12. And that is, if you look at kind of the -- I'll call it the bottom line synopsis of STERIS, we have provided mid-single-digit level growth in the past 10, 12, 13 years in terms of revenue and also double-digit earnings growth. That is our go-forward, long-term view, and that is our objective. Again, we've had the good fortune to be able to do that for the last 13 years in some pretty tough environments. Obviously, this year is a bit of an off year due to the COVID situation, but we certainly see the future to be able to continue to do that. We are, without question, one of the most significant players in the space of sterilization and disinfection. And we cross, again, all 3 of these market segments. And that is unusual to be in all 3 spaces. We have a number of competitors, good competitors, across each one of these spaces, but it is rare for them to cross into -- from Healthcare to Life Science and into the AST or medical device business. I think that's a decent summary of STERIS. Now turning to Cantel. We are very excited about this potential acquisition. We feel very good about the work that they have done. We've admired their company for a good long time. It really is a couple of things together. And it's mainly the fact that we have either broadened or deepened our relationship in places where we either are or want to be. And the issue there is largely around the combination of spaces, that they also work in the disinfection and sterilization business. At a high level, the overview of Crystal (sic) [ Cantel ] is they have 4 business segments also largely centered around their customers, as you will see. The first is the Medical business, which is the largest business in their space, makes up a little less than half. And that business is generally centered around endoscopy, generally centered around high-level disinfection and then some accessories in the endoscopy space. That is very much an area that we are interested in. We generally have very, very little footprint in the high-level disinfection area, and our accessories tend to be different, so we are broadening the line in the endoscopic area. Their second and, again, a little less than half of the business is in the dental space. They have 2 businesses that they have put together in that space, Crosstex and Hu-Friedy, both excellent businesses. Hu-Friedy is the most recent acquisition. I can say we're envious of their foresight in that. And we -- that is an area, as you've heard from my discussion of customers, that we have not gotten into. And again, the Dental is very much like the other areas we serve. It's a procedural space that requires disinfection and sterilization. And we believe we can broaden -- as they have, we can broaden out from sterilization and disinfection just as we have in the operating room space and just as we have in the central sterile space in the hospital area. So we're excited about bringing that customer extension into our portfolio and believe it's an opportunity for growth going forward. The third area is life sciences. It's interesting that we both use that term. We have slightly different variations in that space, but interesting enough, the technologies are similar in some respects. We do water sterilization in our operations in Finland, largely for European markets. Their water sterilization is, generally speaking, for dialysis but, again, obviously similar type of operations. The smallest segment is dialysis. That's an area that we have not been in. It's a historic area for Cantel. It's about a $30 million space and, clearly, something that they've been doing a long time. The overall size of the business, they're about $1 billion. So this is a significant -- in revenue, I should say. This is a significant acquisition for us. Again, we think there are a great number of synergies. The early-on synergies, at least, are clearly on the cost side. Although we do face the same or similar customers in most cases, we tend to have different products and services, and so it adds to those products and services. But since we manufacture capital goods, single-use goods as well as chemistries and new service, which is pretty rare really to do all 4 of those things, and since Cantel does the same things, we think there are a number of opportunities for synergies across the operational spaces and also the normal corporate synergies that occur when 2 public companies come together. All in all, we're expecting about $110 million in synergies in the relatively short term, 4- to 5-year time frame, certainly within 4 years, I should have said, and more than half, roughly half in the first couple of years, so front-loaded. As a result, simply on what our view of our markets and their markets and our revenues and profitability going forward are, we easily see meeting our hurdle rates both in the IRR function, so we easily achieved that hurdle rate; and we also look at ROIC in the 3- to 5-year time frame, and we exceed our hurdle rates there. So that is -- and that is simply on the businesses as they are plus the cost synergies. This is, we think, an excellent strategic fit between our 2 companies. Hard to describe a better strategic fit and unusual in that we are in same or similar places with expansion of products and services and, at the same time, the ability to rationalize some of the operations within those. So as a result, we think the long term of this will create revenue synergies. We have not baked in any revenue synergies into our forecasting or modeling that gets us over our hurdle rates, but we do expect in the long term to see synergies come out of this. With that, I will turn back to Page 12 of the conversation in the JPMorgan package. And the great and interesting thing about this is that page summarizes STERIS and Cantel if you just add the line "and dental" at the end of the first paragraph. It's an expansion for us. We're excited about that expansion. We think it's a good market, and we think that infection prevention is probably at the high end of the growth area of that market, and so we're looking forward to working with our friends at Cantel. That wraps up my prepared conversation, and I am more than happy to take questions, Sarin, from you or from the audience.

Thank you, Walt. That was really helpful. So before we jump into kind of some of the fundamentals at STERIS, I think, like you mentioned, top-of-mind for most investors right now is this acquisition, so I'd like to kind of touch on that a bit more.

Sure.

So you called out, I think, about $110 million in pretax synergies here, and I think you walked us through some of this. So I think first thing is what do we think about in terms of that split? How much of that is coming from the corporate overhead management side? And how much of that is coming in through operational, right? And I think you called out about half of that $110 million in the next 2 years, so I just want to think about how -- we're trying to put these in our models. How much of this is coming through the operational side?

Sure. I don't think we're breaking that out at a detailed level, but it's a significant component of the synergies coming out of the -- I'll call it the combination of corporate overhead, not half but certainly a very significant component. The operational pieces are spread across the organization. We think there's -- they have a significant service force. We have significant service forces both in the Healthcare business and in the Life Science businesses. And one of the real opportunities in service, you're always trading off the number of things that people can do, the knowledge they can have and then the windshield time. And windshield time hurt you in service. And we think there's great opportunity. We have -- in areas of high concentration, we have dedicated service people. As the concentration is lower, yes, we -- in the Healthcare, Life Science, service people do both. They have kind of similar issues, so we think there's real opportunity to consolidate and reduce windshield time and still do as well or probably better service, so as good or better service. So we think that's a real area for us. In the production space, we have -- again, although our products are not largely overlapping, we have a few that we do the same thing, but generally speaking, they're not overlapping. But the technologies within those products and the type of manufacturing in those products is, so we think there's opportunity in the operational and manufacturing space for integration. And we do think there's also some opportunity for, let's call it, building footprint going forward. So those areas on the operational side to us are pretty clear. I think probably those are the ones that come to mind the most. We also will be looking at the sales area. In general, by the way, in sales and service, we are -- if anything, we're concerned about our ability to continue to have enough of those folks. Service technicians are getting to be harder and harder to find and to train, and so I suspect a good piece of this will come out of what we would have already hired. And then, of course, both of us have slowed down hiring dramatically during the pandemic. So as we come out of the pandemic, we would have expected to be hiring anyway. So although not everything can come out of future hiring or attrition, in our view, but a great piece of this, particularly in the field, we would expect to.

Great. I think that makes sense. I think I might have missed this, but you've touched on the longer-term opportunity. You're having some synergies on the top line as well. How should we think about where those revenue synergies are created? And what kind of opportunities do you have as part of this combined company?

Well, yes, so I mean in -- since some of the customers or many of the customers, I should say, if you look at their endoscopy business, what they call Medical, that's a piece of what we call Healthcare. So as we gain footprint in the endoscopy area, we think that will strengthen our business. And of course, endoscopy is largely, not completely but largely a part of the major health systems of -- in the U.S. at least, and so it gives us more footprint in terms of our ability to work with our customers. So we believe that strengthens our position. They also have done some work in Europe. As you probably know, we've been working to expand our footprint in Europe. And they have done a nice job doing the same things, so it gives us more heft in the European markets, again, not typically overlapping products but complementary products. So, a, we have a broader product set; and b, it gives us more heft in those. So again, it helps us to have leaner operations in those areas and, at the same time, provide more products and services to our customers. So those are probably the most significant long-term ones in the Healthcare business. In Life Science, same thing, we have service operations around, and they do as well. And so crossing those service operations, we think, is significant both in the U.S. and particularly in Europe. And then, again, the technologies, although the products may serve different markets or may serve different things, just like we share most of our facilities in -- between Healthcare and Life Science in our business, so if you're making a sterilizer for a hospital or making a sterilizer for Life Science, it can often be in the same facilities; or a washer, the same kind of thing. We expect the same types of synergies across the spectrum with our friends at Cantel.

Great. So within Cantel's business line, you have about 1/3 or so coming from its Dental business. And I think that's been a place where investors have had a little bit more of a hurdle to understand why this fits within your existing portfolio just because it's not necessarily a space you have much exposure to right now. I mean it's growing at -- Cantel's Dental business is growing around 5% to 7% organic. So that's kind of in the range of the 6% to 7% that STERIS is growing or looking to grow. And we've seen some softness in the dental market more broadly, not necessarily in sterilization specifically but just within dental. So maybe kind of help me understand how this integrates within your portfolio now or what your plans are to your strategy here for portfolio management as you enter a space where you might not necessarily have as much exposure to right now.

Sure. That's a great question. And again, the step back there is, when you think about us in our Healthcare business, which is obviously the largest business, we're not in all of health care or all of the hospital or all of ambulatory-type facilities, that we tend not to be on the medical side. And so we are absolutely focused on the procedural side of the business. And that comes from our roots, right, the fact that where the procedures are is where you have to be clean and sterile. So it's complementary to that business. So that's why we're in tables, lights and booms and other infrastructure in the operating room, Operating Room Integration Systems. That's why we entered the U.S. endoscopy with the US Endoscopy acquisition 8 years or so ago. It's because that space is the space we understand. Those are the same customers we understand. And so we appreciate that. Dental, there are parts of dental that clearly cross over, right? Oral surgery is indeed the same thing. Sometimes it's done in the hospital facilities, and we're seeing more and more combination or integration across that space. But it is truly a procedural business in health care, and so a lot of the instruments are similar in nature. They require the same kind of cleaning and disinfection in nature. It's an area that we have considered and just not found a way to -- for us in a way that we thought made sense to enter. So for us, it's just a great opportunity to expand to another group of procedural medical providers, not unlike what we did with US Endoscopy 8 years ago. So that's the first point. The second is in terms of its growth rate in general, I'll call it the long-term growth rate as opposed to short-term growth rate, that growth rate is in that 4% to 6% space. That's kind of the way we think about Healthcare in general. Our piece of the business is kind of a mid-single-digit grower by itself. If we can pick up a point or 2 of share of wallet in that space, that's what we expect to do. If we happen to get a little price on top of that, and then the next thing you know that gives us mid- to high single-digit at a point or 2 from acquisitions and that gives us a mid- to high single-digit revenue growth, and on that, we're very comfortable that we can get into the double-digit profitability space. That's exactly our mantra in our Healthcare business, and it fits perfectly with the dental scenario. You are correct that both dental and endoscopy have been under -- were under pressure this past year because they are more deferrable or some people call it elective procedures. I think it's more deferrable procedures. And through the pandemic, that clearly puts a little tougher. But we look at this as a long-term opportunity, not a short-term opportunity. And just like we saw, our US Endoscopy business fall off, clearly, 70%, 80% in the peak of the pandemic last year -- this past year, and it snapped back to almost normal by this time. The Dental business did something similar, and it is snapping back, from what we understand from dental providers. So we think the long-term situation is very similar, so we're quite comfortable in that space.

Great. So just one more question here on Cantel before we kind of move back into some of the fundamentals here at STERIS.

Sure.

So with the endoscopy business you have, what you're gaining through this acquisition and what you also had through the Key Surgical, I think one thing that's been a bit of a concern for investors is like any sort of antitrust concerns here. Your -- I don't know how much of these markets are you kind of widening into? And how deep are you getting into some of these markets? Is that something that should be a concern as we think about the next couple of years and as you expand your business?

Yes. We've been working on Key Surgical for, I don't know, 4, 5 years now. When our friends at Water Street purchased the business, we were trying to purchase it, too. And they were just more successful than we were 4, 5 years ago, whenever that was. And we let them know that if they improve that business, we'd be very interested in talking. So this year turned out to be a good year for them and us to do that. We see it as a step-wise move with Cantel. The Key -- it's Key Surgical, it's called Key surgical, not key endoscopy, for a reason. That was their beginnings, in the surgical space, and fits very nicely with our central sterile and surgical business. Their endoscopy business is more European than -- it's predominantly in Europe. And so that -- and both we and Cantel have some business over there, but it's not as large as our footprint in the U.S., so we don't see it being a particular issue in terms of regulatory issues in that regard. We do think it's very nicely complementary. Our product areas will help strengthen what Key has done over in Europe, our -- and vice versa in the U.S. So it's a great complement. I know that my friends at Cantel were very interested in the Key business at the same time as we have been, and so we see it as a step-wise function to put the 3 together.

Great. So I'd like to just kind of step back here and just look at STERIS as a whole. So you've been kind of in a unique position. And for maybe investors who are newer to the story, you have some parts of your business that have kind of been benefiting from the sort of COVID environment and then some that are more exposed to the procedure deferrals component. So you have certain businesses sort of serving as a hedge to others. So maybe you could kind of just quickly run us through how investors should think about the puts and takes in some of your businesses going forward, maybe also what you're seeing in terms of latest COVID-19 trends. How are each of these business lines impacted by the pandemic obviously in their own different ways?

Sure. We have that situation, as does Key, as does Cantel, because all 3 of us have businesses that relate to PPE, protective equipment, for health care providers. And so as you might expect, those parts of the business are on fire positively, if you will. In our business, the piece that is most centered around PPE is the AST business, where we are sterilizing things for other people. Now not all protective equipment needs to be sterile. Most of it, in fact, doesn't. But if you're talking about surgical gloves, gloves that are used in the surgical areas or in endoscopy or other places where you should be either high-level disinfectant or sterile, gowns that require sterility, so that area for us is, as you might expect, very, very strong. The same, Key provides those types of products, as does Crosstex -- excuse me, Crosstex for Cantel. And then Key has some of those products as well principally in Europe. So that -- those areas are very strong right now. On the other hand, anything that has to do with basic procedures back in the May, June time frame got -- that May, June, July, I suppose, time frame got reduced significantly. Our AST business has those, so there was a balancing effect between PPE and the procedural types of equipment that we -- or products that we sterilize. Our areas where we are doing outsourced reprocessing or any of our reprocessing chemistries, for example, tended to slow down in that time for the same reasons. Similar things with both Cantel and Key. So there is a trade-off there. It is good to have hedge. Obviously, it's better for us on COVID times in total, but it's good to have that hedge. So we have not been hit as hard as some companies have. In terms of trends, we spoke through kind of October in our last quarterly conference call. I can't obviously speak about any further than that right now. We'll be talking about that February 3 in our announcements. But in terms of what we see tracking, clearly, the places that have had very, very strong resurgence of COVID, we've seen -- it appears that they have slowed down some of their procedures, so the U.K., obviously, Southern California, a few other hotspots in the United States. I mean everyone is somewhat of a hotspot right now, but some stronger than others. But I do think the -- well, I'm certain that the knowledge that the caregivers gained in, I'll call it, round 1, both in terms of how to treat patients, which is fantastic for the patients, it's almost miraculous how great the medical community has come together and found ways to help these people early on, to do proning instead of putting people on ventilators as quickly, to give some prophylactic drugs or treatments. And so they've just done a fantastic job. As a result of that, they can handle much more COVID and keep people alive and keep their facilities running. And they've also separated things both by moving things to ambulatory surgery, as you know, most health systems have robust ambulatory surgery facilities; or by splitting their facilities into these 5 who are doing more surgery and medical patients who do not have COVID, and these 2 are kind of the COVID-designated facilities kind of thing. And so they've done a much better job of keeping everything running this time. I think we will see that continue. So I don't think we'll see the strong dip that we saw before when they really didn't know what they were facing and really didn't know what they were doing. We had a lot of hospitals all around the world that shut down their procedures in order to prepare for or be ready for COVID that never happened. So that was disastrous for them, both financially obviously because they tend to make more money on procedures to begin with, and then they weren't running the medical side. I don't think we will see that level of reduction this time. When it hits peaks in certain places, I suspect we will, but I don't think we'll see the same level of reduction unless it gets much, much worse.

Great. Riding right off that, about 1/4 of your business or so is exposed to capital. And so what -- we had a winter that was, I guess, slightly higher than we anticipated in terms of the COVID case, those we were seeing. And with the vaccine roll that's coming in slower than anticipated, it's here to stay for a bit of time. So could you talk a little bit about what the hospital capital equipment environment has been looking like in the past couple of months or so? And is it something that's significant enough that we could start to expect a softer first half of calendar '21 due to this?

Yes. I've been in the capital equipment business most of my career in health care, which is over 30 years. And I look back -- when I first came, I look back on it for probably 10 years before it. What we see is that capital equipment abhors a vacuum and loves change. So we have a couple of abhors a uncertainty vacuum and loves change. So what we have going on right now is I think there is -- well, I'm certain there is less uncertainty on the part of hospitals view of the world. Last year, they had tremendous uncertainty, and they really didn't know what COVID was going to do to them. They really didn't know how long it lasted. They really didn't know what they had vaccines. So they took the approach that I think most of us took, which is to conserve cash and work hard to not get themselves extended. I think, although it's not to say there's not uncertainty going forward, we all know that we have vaccines coming. They seem to be working. They seem to be working against the strains. They are much better positioned to treat patients. Probably their biggest concern right now, from what I hear from hospital CEOs, is that -- or health care system CEOs, their biggest concern is their staff, the pressure their staff is under, the hard work their staff is under. And so that's kind of their, in my view, #1 concern. I do think that they may reduce capital expenditure some just because of the uncertainty. But on the other hand, they're going to want to, in my view, spend money that helps their staff. And so what we saw last year was if they had strategic capital being spent. So if they're building a new tower or renovating 20 ORs or whatever, that -- those projects rarely slow down or stop. Once there's kind of steel in the ground, they move forward. But it's the replacement capital that tends to slow down. We definitely saw that in the early part of the pandemic. Fortunately, we started the year with great backlog, so it didn't affect us very much. It affects us but not as much as it might have. And then as we reported in October, through October, from kind of mid-summer to October, we've seen sequential growth in capital orders and backlog in our system and through the October time frame, basically approximating last year's rate. Again, we're not going to comment beyond that at this point in time. But in terms of my expectations, as long as they see this is as, hey, we've got a few more tough months and get through it, they're going to spend the strategic capital for sure. They're going to continue, in my view, to spend the strategic capital. They may cut back some capital. But when that occurs, the surgical areas tend to do better than others. And they've gone through the large piece of the IT infrastructure work that they were doing. The strategic capital, they will continue. We tend to do a little bit better as a percent of the capital spend if times are a little tough, so we're -- we even -- as I mentioned in October, we're more optimistic than we were 3 or 4 months ago.

Great. I had a question come in here from an investor regarding competition in some of your key end markets. So for example, Sotera Health is a name that comes to mind in the lab medical device industry. How does STERIS differentiate itself here? And in these markets, has it come down to pricing? Or is the services and products you offer, the mix you offer actually a differentiator?

Yes. We have good competitors in virtually every component of our business. I guess I should say every component of our business. And many of them are larger companies than us. They're significant. They're good at their work. We don't have any competitor that crosses the full spectrum of sterilization and disinfection that we do. So we do think in those spaces, we have an advantage because we are absolutely technology neutral. We use virtually every technology, general type of technology to do sterilization or disinfection in some place. And so we have a lot of knowledge that -- and then the same in the regulatory space. In terms of specifically the AST portion of our business, where Sotera is one of our competitors, I think the answer is we both have a broad network, which is an advantage to have a broad network. They've been an excellent competitor for a long time. They've been in the space a long time. But it's -- in many cases, it is a geographical question. And the key is to have -- typically, I should start this conversation with, typically, the cost of sterilization is often less than the cost of transportation. And so it is very important to have the right technology in the right location for the customer who requires it or the multiple customers who require them. And we and Sotera have a broad network, and we have worked with our customers to be in the right spaces. Some of those spaces, we're close to each other. In some of the spaces, we're not. So in some cases, they have a better position geographically than we. In some places, we have better than them. We both work on long-term contracts, so 3 to 5 years typically with our customers, and that's the most common thing. So you don't see radical changes in market share over time or customer swapping, if you will, over time. But we compete very hard, first, on quality. Because this is a very, very important piece of the process for our customers, so quality and regulatory issues are, in my view, the first and most important thing. And then secondly, we obviously compete on price. So there's no free lunch in the world. We both compete on both, and I expect to continue to. And by the way, there are a number of other competitors, and the biggest entity in that space is people who do it themselves. So the OEMs, particularly the larger OEMs, often have their own facilities. So they rarely do all of their own sterilization. Usually, they do some. And we -- the rest of the outsourcing industry does the balance. But that's by far the largest competitor for both Sotera and us.

Great. Thank you, Walt. There's quite a few questions I could get to, but unfortunately, we're running up on time here. So with that, I want to thank everyone for joining, and thank you all for your time today.

It's a pleasure. I look forward to being back next year in person.

Yes, of course.