Business Context and Reporting Period
STERIS plc provides infection-prevention, procedural, sterilization, testing, equipment, consumable, and related services to healthcare and life-sciences customers. This unaudited Form 10-Q covers the quarter and six months ended September 30, 2020, representing the second quarter and first half of fiscal 2021. Prior periods were recast to combine the former Healthcare Products and Healthcare Specialty Services segments into Healthcare.
The reportable segments were Healthcare, Applied Sterilization Technologies, and Life Sciences. The financial statements were reviewed by Ernst & Young LLP, not audited.
Key Financial Metrics
| Metric | Three months ended September 30 | Six months ended September 30 |
|---|---|---|
| Revenue | $756.1 million, up 2.6% | $1,425.1 million, down 0.6% |
| Gross profit | $330.0 million | $615.6 million |
| Gross margin | 43.6%, versus 43.2% | 43.2%, versus 43.6% |
| Operating income | $141.3 million, versus $126.7 million | $255.3 million, versus $236.8 million |
| Net income attributable to shareholders | $105.9 million, versus $94.8 million | $194.0 million, versus $179.4 million |
| Diluted earnings per share | $1.23, versus $1.11 | $2.26, versus $2.09 |
| Cash dividends declared per share | $0.40, versus $0.37 | $0.77, versus $0.71 |
Product revenue was $339.5 million in the quarter and $640.6 million for the six months. Service revenue was $416.6 million and $784.5 million, respectively. Six-month operating results included $13.2 million of COVID-19 incremental costs, compared with none in the prior-year period, while the company also benefited from lower SG&A and interest expense.
Segment Performance
| Segment | Quarter revenue change | Six-month revenue change | Six-month operating income |
|---|---|---|---|
| Healthcare | $470.9 million, down 3.0% | $870.6 million, down 6.5% | $187.2 million, down 3.3% |
| Applied Sterilization Technologies | $169.5 million, up 10.9% | $321.9 million, up 4.8% | $140.8 million, up 5.5% |
| Life Sciences | $115.7 million, up 17.2% | $232.6 million, up 19.0% | $94.9 million, up 45.2% |
Healthcare was affected by reduced elective procedures and lower capital spending during the pandemic. Applied Sterilization Technologies benefited from higher volumes, while Life Sciences benefited from demand from pharmaceutical customers focused on vaccines and biologics. Healthcare backlog was $178.0 million at September 30, 2020, down from $199.3 million a year earlier; Life Sciences backlog was $74.8 million, up from $69.7 million.
Cash Flow, Debt, Liquidity, and Balance Sheet
- Six-month cash provided by operating activities was $296.1 million, compared with $260.0 million in the prior-year period.
- Free cash flow, a non-GAAP measure, was $185.6 million, compared with $162.0 million.
- Capital expenditures and purchases of property, plant, and equipment and intangibles were $110.7 million, compared with $98.2 million.
- Cash and cash equivalents were $312.0 million at September 30, 2020, compared with $319.6 million at March 31, 2020.
- Long-term debt was $1.021 billion, down from $1.151 billion at March 31, 2020. Debt included $170.3 million under the Credit Agreement and $853.3 million of private-placement debt.
- Debt-to-total capital was 21.9% at September 30, 2020, versus 25.3% at March 31, 2020 and 26.9% at September 30, 2019.
- The company paid $65.6 million of dividends during the first six months and suspended share repurchases on April 9, 2020. Approximately $333.9 million remained available under the repurchase authorization.
Operating cash flow benefited from working-capital improvements and deferred tax payments under government COVID-19 relief programs. The company stated that existing cash and operating cash flow are intended to fund capital expenditures and other liquidity needs, but additional borrowing or equity financing could be required if those sources are insufficient.
Material Changes Versus the Prior Comparable Period
- Second-quarter revenue increased despite pandemic-related pressure on Healthcare, led by Applied Sterilization Technologies, Life Sciences, consumables, and favorable currency movements.
- First-half revenue declined modestly because reduced elective procedures negatively affected Healthcare, particularly in the first quarter.
- Second-quarter gross margin improved by 40 basis points due to pricing, mix, and productivity, partially offset by COVID-19 costs. First-half gross margin declined by 40 basis points because COVID-19 costs and lower productivity exceeded pricing and mix benefits.
- SG&A decreased 1.8% in the quarter and 7.6% for the six months, primarily from lower compensation-related, travel, and meeting expenses.
- Interest expense declined $1.8 million in the quarter and $2.7 million for the six months, primarily because of lower floating interest rates.
- The company recognized $14.6 million of previously deferred capital-equipment revenue and related costs in the first quarter after determining that certain contracts contained multiple distinct performance obligations.
- Currency translation generated $105.9 million of other comprehensive income for the six months, compared with a $64.9 million loss in the prior-year period.
Outlook, Commentary, Risks, and Unusual Items
Management did not provide a specific fiscal 2021 revenue or earnings guidance figure in the supplied filing. Management stated that the pandemic has caused unpredictable demand, with reduced demand for some healthcare products and services and increased demand for certain pharmaceutical-related offerings. Manufacturing facilities continued operating, but the full effect of COVID-19 on future results, financial position, and cash flows could not be reasonably estimated.
On October 2, 2020, after the quarter ended, STERIS agreed to acquire Key Surgical for $850.0 million in cash, or approximately $810.0 million net of tax benefits, subject to customary adjustments. The company expected closing before December 31, 2020 and planned to fund the transaction with cash and debt, including a committed $550.0 million senior unsecured three-year term loan. Acquisition-date asset, liability, goodwill, and intangible values were not yet available.
The IRS has proposed adjustments concerning the deductibility of interest on certain intercompany debt for fiscal years 2016 through 2018. The proposed cumulative tax liability is approximately $40.0 million. STERIS is contesting the matter, has not recorded a reserve, and stated that an unfavorable result is not expected to materially affect financial position but could materially affect results and cash flow in one period.
Other risks include COVID-19 disruptions, elective-procedure volumes, supply and production interruptions, regulatory and product-liability matters, pricing pressure, foreign exchange, tax-law changes, litigation, credit availability, and the ability to complete and realize expected benefits from the Key Surgical acquisition. The company reported no material off-balance-sheet arrangements and stated that its market-risk exposures had not changed materially since March 31, 2020.
Important Facts for Investors to Verify
- Whether elective-procedure volumes and Healthcare capital spending recover, and how that affects Healthcare revenue, backlog, and margins.
- The sustainability of Life Sciences and Applied Sterilization Technologies growth and the extent to which pandemic-related demand is recurring.
- The impact of COVID-19 incremental costs, government tax-payment relief, and temporary expense reductions on future margins and cash flow.
- Final financing terms, purchase accounting, leverage, integration costs, and expected synergies associated with the Key Surgical acquisition.
- The status and potential cash and earnings impact of the IRS intercompany-interest tax dispute.
- Whether operating cash flow and liquidity remain sufficient after acquisition funding, capital expenditures, dividends, debt repayments, and other commitments.
- The effect of the accounting change that accelerated recognition of $14.6 million of capital-equipment revenue and related costs.