STERIS plc Form 10-Q Summary
Reporting period: Three months ended June 30, 2019, representing the first quarter of fiscal 2020. Prior comparable period was the three months ended June 30, 2018. The interim financial statements are unaudited and prepared under U.S. GAAP. STERIS completed its redomiciliation from the United Kingdom to Ireland on March 28, 2019.
Business Context
STERIS provides infection prevention and procedural products and services to healthcare, pharmaceutical, medical device, and research customers. Its reportable segments are Healthcare Products, Healthcare Specialty Services, Life Sciences, and Applied Sterilization Technologies.
Key Financial Metrics
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Total revenue | $696.8 million | $638.8 million | 9.1% increase |
| Gross profit | $305.8 million | $269.1 million | 13.7% increase |
| Gross margin | 43.9% | 42.1% | 180 basis-point increase |
| Income from operations | $110.1 million | $94.4 million | 16.6% increase |
| Net income attributable to shareholders | $84.6 million | $70.0 million | 20.9% increase |
| Diluted EPS | $0.99 | $0.82 | 20.7% increase |
| Cash flow from operations | $109.3 million | $100.8 million | Increase |
| Free cash flow | $59.6 million | $75.8 million | Decrease |
Service revenue increased 8.1% to $389.1 million, consumable revenue increased 8.5% to $160.1 million, and capital equipment revenue increased 12.5% to $147.6 million. The filing attributes revenue growth to organic growth across all segments, partially offset by unfavorable currency movements.
Cash and cash equivalents were $238.1 million at June 30, 2019, compared with $220.6 million at March 31, 2019. Long-term debt was $1.210 billion, including $330.1 million under the Credit Agreement and $883.7 million of private placement debt. Debt-to-total capital was 27.2%, compared with 27.1% at March 31, 2019. The company paid quarterly dividends of $0.34 per share, totaling $28.8 million.
Material Changes Versus the Prior Comparable Period
- Revenue growth was broad-based, with segment revenue increases of 6.1% in Healthcare Products, 11.2% in Healthcare Specialty Services, 13.9% in Life Sciences, and 10.6% in Applied Sterilization Technologies.
- Gross margin improved primarily from productivity gains, pricing, favorable currency effects, and mix. The Fiscal 2019 Restructuring Plan reduced gross margin by approximately 10 basis points.
- Operating expenses increased 12.1%, driven mainly by higher selling, general, and administrative expenses, including compensation, bonuses, and commissions. Research and development expense decreased 3.9%.
- Interest expense decreased by $1.3 million, primarily due to lower outstanding debt levels.
- Operating cash flow increased, but free cash flow declined because capital expenditures rose to $49.8 million from $27.7 million, primarily for expansion projects in Applied Sterilization Technologies and Healthcare Specialty Services.
- The company used $35.0 million for two minor acquisitions and sold its Healthcare Specialty Services operations in China, recognizing a pre-tax loss of approximately $2.3 million.
- STERIS adopted the new lease standard on April 1, 2019, recording approximately $120.6 million of operating lease right-of-use assets and liabilities without a material effect on income or cash flows.
Outlook, Risks, Contingencies, and Unusual Items
No formal full-year revenue or earnings guidance is provided in the filing. Management identifies demand drivers including aging populations, increased healthcare procedures, concern about hospital-acquired infections, pharmaceutical regulatory requirements, and customer efficiency initiatives.
- The Fiscal 2019 Restructuring Plan involves closing manufacturing facilities in Brazil and England, rationalizing products, and eliminating fewer than 200 positions. Cumulative pre-tax charges were $43.0 million through June 30, 2019; additional charges are not expected to be material.
- Remaining performance obligations were approximately $921.0 million at June 30, 2019. Approximately 47% was expected to be recognized within one year and approximately 47% beyond one year; the balance had not yet been scheduled for delivery.
- The IRS proposed tax adjustments related to the deductibility of interest on certain intercompany debt for fiscal years 2016 and 2017. The proposed adjustment would result in an estimated tax liability of approximately $25.0 million. STERIS is contesting the matter and has not recorded a reserve. An unfavorable outcome is not expected to materially affect financial position but could materially affect results or cash flow in a single period.
- The company remains subject to legal proceedings, product liability claims, regulatory matters, tax audits, and other contingencies. Management believes probable and estimable matters are adequately reserved and does not expect current matters to materially affect consolidated financial position or results, while acknowledging that outcomes are uncertain.
- An FDA warning letter concerning operational processes at the Albert Browne subsidiary remains disclosed; STERIS states that remediation measures have been finalized and does not currently expect a material financial impact.
- Key risks include foreign currency movements, pricing and cost pressure, regulatory actions, product approvals, supply or production disruptions, litigation, tax law changes, Brexit and other geopolitical developments, acquisition and restructuring execution, customer demand, and credit-market conditions.
Important Facts for Investors to Verify
- Whether revenue growth and improved gross margins are sustained after currency effects and restructuring impacts.
- The timing and return profile of the elevated capital expenditures and Applied Sterilization Technologies expansion projects.
- Progress and remaining costs associated with the Fiscal 2019 Restructuring Plan.
- The resolution and potential cash impact of the approximately $25.0 million IRS proposed tax adjustment.
- Debt repayment requirements, borrowing capacity, interest rates, and the effect of additional acquisition or share-repurchase activity on leverage.
- The performance and integration of the two acquisitions completed during the quarter and the effect of the China divestiture.
- Whether backlog trends support future capital equipment revenue, including Healthcare Products backlog of $187.2 million and Life Sciences backlog of $58.9 million at June 30, 2019.