STERIS plc: Fiscal 2020 Second-Quarter 10-Q Summary
Business context and reporting period
STERIS provides infection-prevention and procedural products and services to healthcare, pharmaceutical, and medical-device customers through four segments: Healthcare Products, Healthcare Specialty Services, Life Sciences, and Applied Sterilization Technologies. The filing covers the three and six months ended September 30, 2019, representing the second quarter and first half of fiscal 2020. The interim financial statements are unaudited and were reviewed by Ernst & Young LLP without reported material modifications.
STERIS completed its redomiciliation from the United Kingdom to Ireland on March 28, 2019. Prior-period comparisons are presented on a consolidated basis.
Key financial metrics
| Metric | Three months ended September 30 | Six months ended September 30 |
|---|---|---|
| Revenue | $736.8 million, up 8.5% | $1.434 billion, up 8.8% |
| Gross profit | $318.7 million; 43.2% margin | $624.5 million; 43.6% margin |
| Operating income | $126.7 million; approximately 17.2% margin | $236.8 million; approximately 16.5% margin |
| Net income attributable to shareholders | $94.8 million; diluted EPS $1.11 | $179.4 million; diluted EPS $2.09 |
| Operating cash flow | Not separately provided | $260.0 million |
| Free cash flow | Not separately provided | $162.0 million |
- Revenue growth reflected organic growth across all segments, partly offset by unfavorable currency movements.
- Service revenue increased 9.6% in the quarter and 8.8% year to date; consumable revenue increased 7.7% and 8.1%, respectively; capital-equipment revenue increased 6.9% and 9.4%, respectively.
- Gross margin improved from 41.9% to 43.2% in the quarter and from 42.0% to 43.6% year to date, driven primarily by productivity and pricing.
- Cash flow from operations increased from $226.7 million to $260.0 million year to date. Free cash flow declined from $169.7 million to $162.0 million because capital expenditures increased.
- Capital expenditures were $98.2 million, compared with $62.5 million in the prior-year period, primarily for Applied Sterilization Technologies and Healthcare Specialty Services expansion projects.
Balance sheet, debt, and liquidity
| Balance-sheet item | September 30, 2019 |
|---|---|
| Cash and cash equivalents | $225.5 million |
| Long-term debt | $1.187 billion |
| Debt-to-total capital | 26.9% |
| Total assets | $5.186 billion |
| Total equity | $3.238 billion |
Debt consisted primarily of $314.3 million outstanding under the Credit Agreement and $876.5 million of private-placement debt. The company had $6.3 million of letters of credit outstanding and approximately $77.2 million of commercial commitments. Management expects existing cash and operating cash flow to fund near-term capital expenditures and other liquidity needs, but notes that additional borrowing or equity financing could be required if available sources are insufficient.
Adoption of the new lease standard on April 1, 2019 added operating lease right-of-use assets and lease liabilities. The company recorded lease assets and liabilities totaling $120.6 million at adoption; the adoption did not materially affect income or cash flow.
Material changes versus the prior comparable period
- Healthcare Products revenue increased 9.0% in the quarter and 7.6% year to date. Segment operating margin improved to 24.8% in the quarter and 24.3% year to date.
- Healthcare Specialty Services revenue increased 8.4% in the quarter and 9.8% year to date. Year-to-date margin improved, although quarterly margin declined to 11.9% from 12.4% due partly to capacity investments.
- Life Sciences revenue increased only 1.5% in the quarter, with capital-equipment revenue down 11.2% because of customer-order timing. Quarterly segment operating income declined 2.9% and margin fell to 32.8% from 34.2%.
- Applied Sterilization Technologies revenue increased 12.6% in the quarter and 11.6% year to date. Segment operating margin increased to 42.8% in the quarter and 43.4% year to date, primarily from higher volumes.
- Net income attributable to shareholders increased 22.4% in the quarter and 21.6% year to date. Interest expense declined $0.9 million in the quarter and $2.2 million year to date, primarily because of lower debt levels.
- Shareholders received dividends of $0.37 per share in the quarter and $0.71 per share year to date. The company repurchased approximately $30.0 million of shares under its authorization during the first six months and had approximately $349.0 million of remaining authorization at September 30, 2019.
Guidance, outlook, unusual items, and risks
The filing does not provide clear quantitative earnings or revenue guidance. Management cited continued demand supported by aging populations, increased concern about hospital-acquired infections, healthcare procedure growth, pharmaceutical regulatory requirements, and demand for medical-device sterilization. Healthcare Products backlog was $199.3 million, down 2.0% year over year; Life Sciences backlog was $69.7 million, up 13.4%.
- STERIS completed several tuck-in acquisitions for approximately $88.8 million, net of cash acquired, during the first half of fiscal 2020. It also sold its China Healthcare Specialty Services operations, recording a $2.3 million pretax loss; the divested business had approximately $5.0 million of annual revenue.
- The Fiscal 2019 Restructuring Plan involves closing manufacturing facilities in Brazil and England, relocating production, rationalizing products, and eliminating fewer than 200 positions. Fiscal 2020 restructuring expenses were $2.9 million through September 30; total plan-related pretax costs since inception were $43.7 million. Additional costs are not expected to be material.
- The IRS issued 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 contests the assertions and has not recorded a reserve; an unfavorable outcome could be material to a single period’s results and cash flows.
- STERIS continues to address an FDA warning letter concerning operational processes at its Albert Browne subsidiary. Management does not currently expect a material financial impact and is awaiting FDA reinspection.
- Key risks include foreign-currency volatility, pricing and cost pressure, supply or production disruption, regulatory and product-liability exposure, litigation, tax-law changes, acquisition and restructuring execution, and weaker demand or delayed customer orders.
- A newly highlighted risk concerns ethylene-oxide sterilization. Regulatory or legal restrictions on emissions could increase costs or curtail the Applied Sterilization Technologies business and could indirectly reduce demand for related healthcare products and services.
Important facts for investors to verify
- Whether revenue growth and gross-margin gains remain organic and sustainable after currency effects, acquisitions, restructuring, and divestitures.
- The pace and return on elevated capital expenditures and the effect of expansion projects on free cash flow.
- Debt maturities, interest-rate exposure, lease obligations, and capacity to fund acquisitions, dividends, and share repurchases.
- The outcome and timing of the IRS proposed tax adjustments and any related cash-tax exposure.
- The regulatory status of ethylene-oxide sterilization facilities and the FDA remediation and reinspection process.
- Whether Life Sciences order timing and product mix normalize and whether segment backlog converts into revenue as expected.