STERIS plc: Fiscal 2020 Third-Quarter Form 10-Q Summary
Business context and reporting period
STERIS provides infection-prevention and procedural products and services to healthcare, pharmaceutical, and medical-device customers. Reportable segments are Healthcare Products, Healthcare Specialty Services, Life Sciences, and Applied Sterilization Technologies. The filing covers the three and nine months ended December 31, 2019, representing the third quarter and first nine months of fiscal 2020. Results are unaudited and presented under U.S. GAAP. STERIS completed its redomiciliation from the United Kingdom to Ireland on March 28, 2019.
Financial performance and key metrics
| Metric | Three months ended December 31 | Year-over-year change | Nine months ended December 31 | Year-over-year change |
|---|---|---|---|---|
| Total revenue | $774.3 million | 11.2% | $2,207.9 million | 9.6% |
| Gross profit | $331.4 million | 15.5% | $955.9 million | 13.7% |
| Gross margin | 42.8% | Up from 41.2% | 43.3% | Up from 41.7% |
| Operating income | $142.4 million | Up from $69.6 million | $379.2 million | Up from $270.6 million |
| Net income attributable to shareholders | $104.9 million | Up from $47.9 million | $284.3 million | Up from $195.3 million |
| Diluted earnings per share | $1.23 | Up from $0.56 | $3.32 | Up from $2.28 |
Approximate operating margins were 18.4% for the quarter and 17.2% for the nine-month period, compared with approximately 10.0% and 13.4%, respectively, in the prior-year periods. Approximate net margins attributable to shareholders were 13.6% and 12.9%, compared with 6.9% and 9.7%.
- Quarterly revenue growth was broad-based: service revenue increased 11.4%, consumables 13.2%, and capital equipment 9.0%. Nine-month increases were 9.7%, 9.9%, and 9.3%, respectively.
- Quarterly segment revenue growth was 8.0% in Healthcare Products, 12.6% in Healthcare Specialty Services, 16.4% in Life Sciences, and 14.3% in Applied Sterilization Technologies.
- Nine-month operating cash flow was $391.3 million, compared with $360.6 million. Free cash flow, a non-GAAP measure, was $238.1 million, down from $252.9 million because of higher capital expenditures.
- Capital expenditures were $153.6 million, compared with $113.2 million, primarily reflecting expansion projects in Applied Sterilization Technologies and Healthcare Specialty Services.
- Cash and cash equivalents were $199.2 million at December 31, 2019, compared with $220.6 million at March 31, 2019.
- Long-term debt was $1.137 billion, consisting primarily of $255.2 million under the Credit Agreement and $885.2 million of private-placement debt. Debt-to-total capital was 25.2% at December 31, 2019, compared with 27.1% at March 31, 2019.
- Quarterly and nine-month dividends declared were $0.37 and $1.08 per share, respectively. Approximately $349.0 million remained available under the share-repurchase authorization at December 31, 2019.
Material changes versus the prior comparable periods
- Revenue growth reflected organic growth across all segments, favorable pricing, and volume growth, partially offset by unfavorable currency effects.
- Gross-margin expansion reflected improved productivity, pricing, and lower restructuring-related costs. Labor costs and other adjustments partially offset these benefits.
- Operating income benefited from higher revenue, improved gross margins, and substantially lower restructuring charges. Prior-year results included significant restructuring charges and a $16.2 million branding-related impairment charge in SG&A.
- Interest expense declined by $1.1 million in the quarter and $3.3 million for the nine-month period, primarily because of lower debt balances.
- The effective tax rate increased to 21.9% from 16.2% for the quarter and to 18.8% from 16.9% for the nine-month period, primarily because a greater proportion of profits was earned in higher-tax jurisdictions.
- STERIS completed several tuck-in acquisitions during the first nine months, with aggregate purchase price of approximately $117.3 million, including potential contingent consideration. It also sold its Healthcare Specialty Services operations in China for $0.4 million of proceeds and recorded a $2.4 million pre-tax loss.
- The company adopted lease accounting guidance on April 1, 2019, recognizing approximately $120.6 million of operating lease right-of-use assets and liabilities without a material income-statement or cash-flow effect.
Outlook, risks, contingencies, and unusual items
The filing does not provide explicit full-year revenue or earnings guidance. Management describes continued demand drivers including aging populations, increased healthcare procedures, hospital-acquired-infection concerns, pharmaceutical regulatory requirements, and demand for medical-device sterilization. Remaining performance obligations were approximately $960.0 million at December 31, 2019; approximately 48% was expected to be recognized within one year and 44% beyond one year.
- The Fiscal 2019 Restructuring Plan involved closing manufacturing facilities in Brazil and England, eliminating fewer than 200 positions, and rationalizing products. Cumulative pre-tax costs were approximately $44.0 million, with additional costs not expected to be material.
- The IRS proposed adjustments concerning the deductibility of interest on certain intercompany debt for fiscal years 2016 through 2018. The cumulative potential tax liability is approximately $40.0 million. STERIS is contesting the assertions and has not recorded reserves; an adverse result could be material to a single period’s earnings and cash flows.
- STERIS faces ordinary-course litigation, regulatory investigations, product-liability claims, and tax audits. Management believes existing reserves are adequate and does not expect current matters to materially affect consolidated financial position, but outcomes remain uncertain.
- The Applied Sterilization Technologies segment faces regulatory and litigation risk related to ethylene oxide sterilization, including potential emission restrictions, facility closures, higher compliance costs, fines, or reduced demand.
- Key forward-looking risks include currency movements, raw-material costs and availability, pricing pressure, regulatory actions, product approvals, supply or production disruptions, acquisition and restructuring execution, Brexit or other geopolitical developments, tax-law changes, and credit-market conditions.
- The company reported no material off-balance-sheet arrangements. Commercial commitments were approximately $79.4 million, and letters of credit under the Credit Agreement totaled $6.2 million at December 31, 2019.
Important facts for investors to verify
- Whether gross-margin improvement and lower restructuring costs are sustainable after the restructuring plan is substantially complete.
- The effect of increased capital spending and expansion projects on future free cash flow and leverage.
- The status and potential cash impact of the approximately $40.0 million IRS intercompany-interest tax dispute.
- Regulatory developments affecting ethylene oxide sterilization and the related impact on the Applied Sterilization Technologies segment.
- Acquisition integration, contingent consideration of approximately $15.3 million at December 31, 2019, and the realization of expected benefits from tuck-in acquisitions.
- Currency trends, international demand, Healthcare Products backlog of $209.9 million, and Life Sciences backlog of $71.6 million.
- Management’s subsequent full-year outlook, which the filing text does not clearly provide.