Okay, morning, everyone. Thank you so much for being here. Patrick Wood, from the U.S. MedTech team. I'm very excited to have Dan Carestio here, CEO of STERIS. Before we start, some disclaimers, there's usually a little board here, so I'm gonna have to go by memory. morganstanley.com/researchdisclosures. Pretty sure that's the one. I'm sure you'll all be going there. Or you can reach out to your Morgan Stanley sales rep, either way, it should be good. Dan, thank you so much for joining us. Really appreciate it. Maybe just to jump right into it, you know, last quarter had some very strong capital equipment trends for you guys. Obviously, you came into it with quite a big backlog, but there's still quite a big backlog.
Maybe could you speak to sort of where you're seeing some of the strengths, the type of demand, products, the durability, any comments around that?
Yeah. I think we've been especially strong in sterile processing equipment, although we've done well on surgical lights and tables as well. You know, a couple of things, Patrick. There's a lot of pent-up demand, a lot of maintenance CapEx that wasn't spent during the pandemic, a lot of healthcare systems that are now seeing a path back to profitability and positive cash flow, whereas, you know, a year ago today, they were hemorrhaging cash, you know. So, although we've remained pretty strong, even during sort of the back end of the pandemic in terms of order rates, and I think that's largely because the equipment we sell is more of a utility that's procedural driven or procedure enabling in terms of making sure you have to have capacity to sterilize and reprocess instruments.
So, the order rates remained high, there seems to be pretty good durability to it. Now, I say that, but I'll also tell you, there's always cyclicality in capital equipment purchasing. There always has been, in the 26 years I've been at STERIS. We've seen that trend, so it's not something I would bank on five years into the future, necessarily. But I think with our portfolio, I think we've probably picked up a little share, and you know, the outlook is pretty positive right now, and we've gotten a lot better in terms of supply chain easing and our ability to manufacture and ship. Whereas a year ago today, we were really having some challenges on some critical supplies, especially electronics.
That's largely not an issue anymore, and we're back to normal operations in terms of output.
Do you get a sense from the hospitals, like, how many projects are proportionately being, like, expansionary in nature, if you like, versus the maintenance side? Like, how's that ratio looking?
It's a higher percentage now than it historically has been on expansion. And I think part of that is because you see a lot of consolidation of hospital systems and movement of hospital systems. There's a definite trend to going out into the communities and sort of getting away from the huge acute care facility downtown and being more, you know, community-based care. So as a result, you're seeing smaller hospitals pop up, other hospitals that are, you know, obsolete, going away, and movement going around. So I think that's fueled some of our growth on the capital side that we've seen.
Obviously, the trend towards ASCs and outpatient care has been something that's kind of been growing for a while. You know, what are the differences for you in servicing that kind of a customer versus a large inpatient facility?
The big thing on equipment is footprint. They're challenged with space, and then the other big thing is utility. The utilities generally aren't as good, so our equipment has to accommodate the utilities in terms of water pressure and air and all that type of stuff. And then also simplifying the equipment so it's easy to use because you have fewer staff, higher turnover, and so we have to do a lot more education with our clinicals to make sure that we keep them running. You know, but other than that, it's important to have a different sort of a good, better, best price tier model of options for them. You know, certain ASCs have a lot of cash and are willing to buy the upper echelon of equipment.
Others might want to buy certified pre-owned equipment, you know.
Do you notice the difference in terms of which surgeries that ASC is supporting, i.e., higher margin surgeries? I don't know, if for certain conditions, outpatient, better pricing.
Yeah, the ortho clinics tend to spend the most money, and, you know, ortho is fine. That's where a lot of the money is, and a lot of those procedures have moved out of acute care into ASCs, and they tend to build out the nicest ORs.
Makes sense. Then, there was also, you know, the med tech procedure volumes are very strong, certainly in the first half of the year. There was a little bit of destocking, from your end in terms of, you know, it seems like supply chains had got better, so people were willing to run with lower inventory.
Mm-hmm.
Have we seen a sort of an end to that? How do you see that playing out for the rest of the year?
You know, we talked about it in last quarter's earnings call, and, you know, my belief is that, you know, by third quarter, I think we'll see demand meet inventory. You know, everybody got bloated on inventory during the pandemic, ourselves included, basically as a cautionary effort to make sure we didn't have stock outs and things like that when there was uncertainty around supply chains. And now, as we see our customers start... You know, they're starting to bleed that down. And I think that crossover happens this fall, because the procedure rates are up, and the volumes that we're seeing, like through AST in Q1, didn't necessarily reflect that because of the destocking.
Now, having said that, I've seen this play before, and there's always a, you know, the inventories go down, there start to be issues, there's an overreaction on production, demand goes through the roof, and, you know, then it takes a while to modulate. So, I think that we'll see that trend play out in the future.
It's an unfair question, because it's more of an industry-wide comment, but, you know, you guys get a good exposure and a good ability to see general procedure volume trends across kind of everything-
Mm-hmm
... more than a lot of other companies. So I guess there's been some worries in the market overall within med tech, that some of the procedure volumes might have slowed, you know, during the summer. I think it's tied, you know, docs take longer holidays and stuff like that. There's always seasonality there, but more so than usual. Is there anything you could give any guidance in terms of what you guys have seen?
You know, I would say in the U.S., we've seen consistent trends of procedure growth and very robust volumes. And intake has improved so much in patient intake. You know, in the early Q1, things like that, we still have seen struggling recovery in Europe. Asia Pacific started to show better, you know, improvement and is moving towards the path. You know, it's-- they're 6-9 months behind us. There's a number of countries that just came out of COVID shutdowns last spring, so it's... But, so we're seeing improvement in APAC. But, but generally speaking, I don't, I don't see any summer seasonality necessarily.
I mean, in Europe, you have the strikes that occur and all the issues with NHS and everything else, but I think that'll modulate itself going into the fall.
Yeah. I'm pretty glad I live in the U.S. now. Maybe you could remind some of the audience about the bioprocessing business, the kind of trends you're seeing there. We hear a lot from, you know, Sartorius and the others.
Yeah.
Just kind of anything you're seeing there, I'd be curious.
Yeah. So, major destocking that happened last year, really Q4 started to happen in Q3, where, their customers had overbought and they had overbuilt in anticipation of that continued demand, and it slowed down significantly. Now, what I would say is there's, you know, a 15-year trend of sterile, single-use disposables that we've seen on a constant, you know, double-digit growth rate since it started showing up in the back of a station wagon 20 years ago, literally, you know, now it's a huge business. And I would expect it to resume that growth once it sort of resets. And we believe that we'll resume, for us anyways, we'll see positive growth next fiscal year. It may cross over to positive in our fourth quarter, which is first calendar quarter.
You, you recently did a reasonably sizable acquisition of the surgical instrumentation business from from BDX. Just curious how you... You know, for the audience who are less familiar with it, how you feel that asset fits STERIS? What was it that made it attractive to you?
Yeah, a couple of things. So their two primary products are sort of durable stainless steel medical instruments used in surgery and sterilization containers. And, you know, almost 100% of what we process going through sterile processing departments, you know, is durable stainless steel instruments. So, you know, whether it's our sinks or our chemistries or our ultrasonics, and they have to go through our washers and our steam sterilizers or hydrogen peroxide sterilizers, and then all the associated products that go into that process, that's all around processing stainless steel, largely in the hospital. So, for us, and also our tracking systems that we track all the instruments through.
So for us, it was a very logical step, you know, and it also gives us an opportunity in the future to position the instruments with the front-end CapEx, as opposed to waiting till three months before the hospital opens and then looking for instruments. And with all the data we have through processing and our ability to help customers, hospitals build more efficient sets and kits, we think we can drive some value there with their customers.
I know it's early days, always difficult to comment, but how are you feeling integrations, you know, going? Is it culturally and business-wise kind of what you thought it might be?
Yeah, it is. It's going as we would expect. The culture seems good. They seem happy to be part of STERIS. It's a good fit for the Mueller assets. And we've got it set up as its own individual business unit within our healthcare group, under procedural. And I think things are going quite well so far. It's been a month, but too early to say.
Yeah.
Yeah.
I guess the other sort of move in the industry is some of the EO regulation on that side of things and how that's going. Maybe for the audience who are less familiar, just a quick overview of, you know, what's happened there and how you view that sort of changing dynamics of the industry or not.
It will change. I would say it goes back, for those who don't know, three years ago, a competitor plant in Illinois was shut down, basically by public opinion, not by regulators. And it's become a real issue with EPA, who is redoing the rule for both the application, which is the FIFRA, and NESHAP, which is the sterilizer operating rule. And the challenge is that 50% of single-use sterile medical devices go through ethylene oxide, and many of those have zero alternative in terms of how they're processed, because they're either not heat stable or radiation stable or whatever it may be, which is most plastics. So having said that, there's going to be significant increased regulation. We fully expect that.
We, Steris, have been working, you know, has made significant investments over a long history in our EO facilities to keep them at the highest level of technology. Going back three years ago, we deployed, basically scrubbing equipment on all of our warehouses, which is going to be part of the rule, we believe, interestingly. I think that, we're happy to operate in highly regulated environments. We know how to do it, and I think that our technology team and engineering team and the ASD group, as it relates to ethylene oxide, have got us very well positioned to meet whatever the requirements are when the rule comes out, which is anticipated to be, first calendar quarter, probably March of next year.
Do you think, for AST and that side of things, do you think a more complicated regulatory landscape might encourage some of the med tech businesses that haven't yet outsourced the sterilization step to partner up with STERIS, given it's just more of a pain in the ass, quite frankly, for them to do it themselves?
Yeah, it's not for the faint of checkbook, and there is regulatory risk involved in it. I mean, to build an ethylene oxide facility of any scale, it's $60 million-$70 million. So, I think we have the expertise. I think we're well positioned. We have a great history with quality and regulatory. And in addition to that, I think you'll also see med tech go upstream in the R&D and look at their manufacturing and materials, and determine whether or not this really needs to go to ethylene oxide.
What currently happens today is, they engineer a product and it gets to the endpoint, and then they come to us or they come to their engineers and say, "How do we sterilize this?" But if you haven't made decisions way up in the process, you end up picking materials that aren't radiation stable, and your only alternative is ethylene oxide. So I do think that you're gonna see innovation in the design that's gonna allow things to move into radiation over time, or maybe also into hydrogen peroxide.
Do you ever work with any of the CMOs, or are they just doing all their own stuff in-house?
We do work with the CMOs. On the pharma side, specifically? Yeah, absolutely. We do, and mostly with our GMP equipment and chemistries for life sciences. A lot of critical environment equipment for maintaining their clean rooms, VHP, hydrogen peroxide for their isolators, for doing aseptic fill, and all those different things. So we're heavily involved both in direct pharma as well as CMOs.
And then, you know, you obviously called out some of the, you know, excess cost inflation and that side of things. I think some of that, from memory, is catch-up of employees who didn't get paid super well, the prior year, getting, you know, made whole, I guess.
Yeah.
You know, how are you seeing the cost inflation environment, maybe outside of labor, because it's kind of sticky, like the other inputs?
Yeah. We're starting to see improvement. You know, a year ago, this summer, we were paying, you know, $70 for chips that we used to pay $3 for. I mean, it was from some kid in a basement somewhere in Arizona, right? That has subsided. We have very good continuity of supply at reasonable prices for our electronics. Those have come back down. As we burn through that higher inventory, you're gonna see that somewhat normalized. That will be somewhat offset with labor inflation, you know, I would say, especially at the manufacturing area. But it's been a local challenge, depending on what market you're in, in terms of rates, and we've found that we've had to be both proactive and reactive in terms of making sure we have people coming into our factories every day to work.
And keeping them staffed has been a challenge, but we continue to manage that. In terms of materials, I think we're in pretty good shape in terms of what we anticipate from an inflation standpoint, and hopefully they come down a bit more.
I know you've always been trying your best not to pass pricing on to your customers, but I suppose in some instances, like you said, $67 million to set up a plan and then you're integrated with that network. When needed under a higher cost inflation environment, how do you feel about your ability to keep passing pricing through?
We have to. It's inevitable, and it's a strike-a-balance type thing, you know? It's not something we necessarily do to try to increase or improve margin, but rather to maintain. And in an environment where labor has gone up, pick a number, 15%-20% in some cases in the last 2.5 years-3 years, it's just something that can't be avoided given the cost, the component of that cost being so critical to both services as well as manufacturing.
I mean, the labor cost inflation side is obviously two components, right? You've got, you know, the actual cost inflation environment, and therefore, labor kind of looking to catch up, but there's also a supply component on labor itself. Have you—like, has that got a little less tight? Are you able to find the people you need, or is it still pretty tough?
It's still pretty tough, but we offset that with culture and wage, and also with... You know, we've talked about this before. We're a lean manufacturing operation, and we do everything we can to eliminate waste, make the jobs better for the employees, as well as, you know, streamline them, so we can do more with less labor wherever possible. So, you know, our continuous improvement efforts, along with, you know, the culture and wage, I think, have helped us quite a bit in terms of making sure that we keep our labor where we need it to be.
I don't think I was bunching packing, but I have to ask the inevitable GLP-1 related question, and if you see it having any effect on the industry.
Yeah, I don't know. What I would say is this: we are a beneficiary of any type of aseptically manufactured drug. Most of the equipment that we sell out of our life sciences group, and the chemistries are used in those processes. I would say that, but also tell you the GLP-1s are this much of total aseptic, you know, manufacturing in the world today. So I don't think it has a huge commercial drive in terms of STERIS. The other question that everybody inevitably asks is, what's the long-term impact on healthcare, given the impact that you've seen on bariatric surgeries and things like that? And the short answer is, I don't know. I've heard everything from, "It's going to be enormously impactful," to, "It's a drop in the bucket," because there are so many other causes of disease that aren't necessarily obesity driven.
So, I'm not gonna try to answer that question, specifically on the long-term impacts on healthcare anyway.
No one has done a good job of that anyway, so it's-
Yeah
... impossible. You actually have a decently sized endoscopy business. Now, how are things going there? How do you see the competitive environment? How do you feel about that?
You know, we went through the full integration over the last two years with Cantel's endoscopy business and our endoscopy business. It went really well. We've got two sister factories that we've really been able to leverage, you know, sort of centers of excellence for different manufacturing environments. The field consolidation went very well in terms of customers. We were challenged last year, separate division, but highly associated with the endoscopic reprocessing business. And so just now, as we've gotten through our manufacturing issues, we're able to really pull that effort together with devices and with AERs. And so we're really excited about that, and it's done really well for us in the last couple of quarters. So, I would say, all in all, it's gone incredibly well. We've got a strong position in terms of the portfolio in the space.
And there's some good competitors in the space, too, as you well know, as there is in many of the spaces we operate. But I think we're positioned to do incredibly well. It's, and it's a good growth market anyways, in terms of GI.
... I know you're agnostic between them, because either ASP or it's healthcare, but are you surprised in some ways at how slow some of the conversion to single use has been, or is that just there was too much hype?
I think it's too much hype. I mean, the reality is that it my personal opinion, and our opinion as a company who has a $500 million scope repair business as well, is that, you know, for very small diameter, high break fix scopes, like ureteroscopes or, cystoscopes or things like that, it can make sense if you get the cost point right on it, I think. In my view, in terms of large diameter colonoscopes and things like that, it would take a technology leap to get those to where they could have a cost, that was meaningful.
And also, there's a sustainability challenge as well, in terms of the amount of plastics and things you'd be throwing away after every single use of a 6.5-foot-long, 7-foot-long scope, so.
You've obviously got a bit of surgical instrumentation and then the endoscopy side, where you're kind of involved in the sterilization and the device in a way. Are there other areas that you've thought about where you're, you know, that sort of marriage could make sense?
We're always looking, but we're also very committed to staying in our narrow fairway, I think, and it's something that has proved us, you know, it's, it's been very good for STERIS for a very long time, is it, it needs to either have a direct association with procedural NGI and/or sterilization, disinfection across, you know, different markets of healthcare. And I say of healthcare, I mean, whether that's pharma, whether that's medtech, whether that's whatever, we're not-- we have not looked at, nor do we anticipate looking on taking that out of, you know, into other consumer or, you know, industrial markets. We just don't think that makes sense. Our, our focus is healthcare.
Do you think, there could be a more systematized way to get involved with hospital sterilization outside of the core areas, like in the broader facility?
Mm.
I'm just thinking about things like, you know, AMR and, like, the, you know, microbial resistance, all that sort of thing, and some of the regulators changing payment rates for patients who end up with surgical infections and things like that. Is there a broader business there?
Yeah, the thing is, with surgical infections, it's seldom, if ever, from the instrument. It's usually from exposure in the OR suite or postop wound treatment. So I don't necessarily... I don't think so. You know, I think what we can do is by having smart equipment and basically feeding the people doing the work and sterile processing the instructions for use, for the instrument they're holding electronically, and doing everything we can to make sure they're processing from sink to sterilizer correctly, it would, and ensuring that compliance with an hourly worker that's getting paid $22 an hour, keep in mind, making sure they have full compliance on that to ensure that the instruments are safe and sterile every time, and making that process easier for our customers.
Maybe could you, could you speak to the competitive environment overall? One of your peers, arguably, might be a little distracted with some issues they've got. I don't know if you see any impact from that.
I don't really ever address our competitive position. We just continually try to improve our position and our portfolio. And what I would say is across our businesses, in particular, in our healthcare SPD, I think it's really tough to beat STERIS right now with the portfolio of products that we have. I also think AST is in a really strong position with our global footprint and with all the investments we've made in X-ray technology that have started to come online and will come online over the next couple of years. I think we're in a really good spot to continue to grow at market plus maybe a little bit above our weight in terms of share.
For those who are maybe less familiar with the sort of growth, oh, God, I use the phrase like growth algorithm, essentially like midterm. Maybe you could paint the expectations for the kind of consistent growth that you feel STERIS could do.
I mean, our long-term stated objective has always been 7 and 11, 7 on top, 11 on bottom, and that's something that we feel that we can consistently deliver on. You may have a year where that gets out of cycle here or there because of inflation or whatever, or maybe higher than that because of acquisitions, but over the long haul, that's been our mantra, and we believe that that's something we've done consistently and will continue to do as a company.
I guess you've got four sort of main stools for the business, and some of, I guess, the investment is customer led in as much as they approach you in some ways.
Right.
Presumably, at the start of the year, you also sat down thinking, like, where are we going to spend a disproportionate amount of our time and money? How does that process work internally?
Yeah, so we have what we call our senior executive board, which is top six executives, including myself. And so those proposals come to our board, our internal board, and we discuss them. And if the risk and the internal rate of return balance is right, we'll make those investments. Fortunately, for the last few years, we haven't had to, you know, push a lot of them back if they were good investments because our cash flow is good and our outlook for cash long term is very good.
In the absence of any major acquisitions, there's a number of things we can do to grow our business internally, whether that's, you know, AST expansions or building outsourced processing centers for hospitals, or whether that's investment in our R&D and new product development, or, you know, a number of other things that we do. But that's how those come forward, and we manage that CapEx.
You obviously have a global presence, but you're a little more U.S. weighted, maybe than some of the customers that you serve. Is there any opportunity to maybe bulk up on the U.S. side of the business?
Yeah. One of our biggest opportunities, I think, is healthcare Europe. And, you know, before, when it was Key and Cantel and STERIS as separate companies, nobody really had the breadth of portfolio. They were good at their little areas, but now we've got, you know, a lot more scale in terms of channel, that we can be a lot more efficient, as well as manufacturing operations in Europe, as well as a much better portfolio, most importantly, from a customer perspective. So we've made good progress. Europe's been slow to recover in terms of procedures, as everybody knows. But I think that it's been positive for us, but I think there's a lot more runway to improve over there.
That's obviously engaging a lot of times with sort of the larger national health services, not just in the U.K., but in, you know, Germany and France, and things like that. Would you envisage that looking at sort of, they try out a couple of contracts to see how it goes, and then you scale from there? Is that how you would see that working?
I think we'll probably go in with product penetration first, where, where we have strength, where we have real strength, so hydrogen peroxide, peracetic acid, you know, endoscopic sterilization, those type of things, and then, then pull in steam and washing with that afterwards.
And then one area that, you know, we obviously don't end up talking about as much is dental. So I'm just curious how you feel about that as an end market. I know it's kind of a cash cow for you guys.
It is a cash cow. It's a slow growth market, and it's been slow to recover post-pandemic, and still has, still has had challenges in terms of just volume. Now, what we have seen is good improvement in terms of overall margin of the business, despite the volumes being down, and a lot of that's because of the CI- continuous improvement in lean work that we've worked with with our dental folks. So I think as the volume come, comes back, they're going to be well positioned to do a little better on margin. But it's, it's, it's not a 10% grower, you know? It doesn't make, doesn't make it a bad business. It's a great business, but, it's not gonna-- It's not at the same high level growth that we've seen in the other businesses at STERIS.
Is that something that you would want to keep it in the group or something that if it became too much of a distraction, you'd consider selling?
It's a workable asset right now, and I think it's a wait-and-see in terms of what the market does long term with dental.
You know, it feels like you probably have all the puzzle pieces in terms of your core market from, you know, healthcare, AST, and the, you know, the life sciences side. But are there any other, like, jigsaw pieces you feel like you might be able to add on?
I don't think so right now. I think what... Within healthcare, we have a procedural group where we have our GI devices, and we have a number of other sort of safety devices that are used in the OR. There is an opportunity to build that out further over time, but right now, our core focus is really operating the business as we have it today in focus.
Most of the med tech companies who's working to have seen it, obviously, so far this year, a backlog come through and a bit of a bolus of procedures, but actually most seem to still think that next year is gonna be a kind of normal year. You're not gonna get a difficult comp effect or something like that. How do you feel about that?
I think there's more backlog that's gonna... I mean, and it depends on where you are. Europe, there's a couple of years of backlog. Now, some of that's just not gonna happen, but orthopedics and things like that, there's a lot of backlog. In terms of U.S., I think it's going to be quite a while before it clears out, at least a year, in terms of. Because they just started, really, the big healthcare systems just started getting positive intake of patients over the spring. And so for those to matriculate towards ultimately having a procedure or being treated for long-term disease, it's gonna take some time. So I think that bolus may last a little longer than people anticipate. And as I speak to hospital system CEOs, that sort of resonates with.
The capital equipment strength we saw at the start of the year, you know, we'll see how long that goes for, of course, but... How should we think about, because, you know, the real money in some ways, the chemistries and we call that the follow on. How do we think about that impact later?
Well, yes, we're replacing a lot of washers and a lot of ARs, and those do push a lot of chemistries, and most of that's proprietary chemistries. In fact, regulated under a 510(k). So, assuming the procedure rates stay up, you know, and those we win on the procedural volume in terms of chemistries, which is generally higher margin products for us.
Is that like one of the key sort of internal KPIs you look at, is like the install base shifting forward, is that?
It is. It's something we look at all the time. If we look back at our history, it wasn't that long ago, 15, 12 years ago, we were 80% capital equipment company and 20% recurring, and now we're 80% recurring, 20% capital. We've grown our capital business significantly. It's just we've made significant effort and focus on the consumables and chemistries and devices as well.
Obviously, you know, you do, you do plenty of these meetings. You, you know, you have a lot of calls with investors and stuff like that, but then you have your actual job internally. You know, where do you, where do you find, like, disconnect is too strong a word, but, you know, there'll be stuff internally that takes up an enormous amount of your time, but no one asks about externally, or vice versa, things people are asking a lot about externally, you know, it's not really a debate internally. Can you think of the topics in that area?
Yeah, maybe not really. I'll give you some, maybe a couple interesting facts on STERIS, you know, if that helps, because there's not a lot that, you guys are pretty perceptive, that we don't get asked about, to be honest with you. But I would tell you this, if you look at the four business units of STERIS, as well as myself, as well as our CFO, as well as our GC, we're all 20+ years with the company, which is not the norm in a lot of industry. The other thing I'd tell you is we've had four CEOs at STERIS, and 50% of them have had zoology degrees.
I'm just trying to think how I'm gonna fit that into the mode. Dan, thank you so much. Perfect on-