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STE > SEC Filings for STE > Form 10-K on 31-May-2016All Recent SEC Filings

Show all filings for STERIS PLC

Form 10-K for STERIS PLC


31-May-2016

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

INTRODUCTION
In Management's Discussion and Analysis ("MD&A"), we explain the general financial condition and the results of operations for STERIS and its subsidiaries including:

• what factors affect our business;

• what our earnings and costs were;

• why those earnings and costs were different from the year before;

• where our earnings came from;

• how this affects our overall financial condition;

• what our expenditures for capital projects were; and

• where cash will come from to fund future debt principal repayments, growth outside of core operations, repurchase ordinary shares, pay cash dividends and fund future working capital needs.

The MD&A also analyzes and explains the annual changes in the specific line items in the Consolidated Statements of Income. As you read the MD&A, it may be helpful to refer to information in Item 1, "Business," Item 6, "Selected Financial Data," and our consolidated financial statements, which present the results of our operations for fiscal 2016, 2015 and 2014, as well as Part I, Item 1A, "Risk Factors" and note 11 of our consolidated financial statements titled, "Commitments and Contingencies" for a discussion of some of the matters that can adversely affect our business and results of operations. This information, discussion, and disclosure may be important to you in making decisions about your investments in STERIS.

FINANCIAL MEASURES

In the following sections of the MD&A, we may, at times, refer to financial measures that are not required to be presented in the consolidated financial statements under U.S. GAAP. We sometimes use the following financial measures in the context of this report: backlog; debt-to-total capital; net debt-to-total capital; and days sales outstanding. We define these financial measures as follows:

• Backlog - We define backlog as the amount of unfilled capital equipment purchase orders at a point in time. We use this figure as a measure to assist in the projection of short-term financial results and inventory requirements.

• Debt-to-total capital - We define debt-to-total capital as total debt divided by the sum of total debt and shareholders' equity. We use this figure as a financial liquidity measure to gauge our ability to borrow and fund growth.

• Net debt-to-total capital - We define net debt-to-total capital as total debt less cash ("net debt") divided by the sum of net debt and shareholders' equity. We also use this figure as a financial liquidity measure to gauge our ability to borrow and fund growth.

• Days sales outstanding ("DSO") - We define DSO as the average collection period for accounts receivable. It is calculated as net accounts receivable divided by the trailing four quarters' revenues, multiplied by 365 days. We use this figure to help gauge the quality of accounts receivable and expected time to collect.

We, at times, may also refer to financial measures which are considered to be "non-GAAP financial measures" under SEC rules. We have presented these financial measures because we believe that meaningful analysis of our financial performance is enhanced by an understanding of certain additional factors underlying that performance. These financial measures should not be considered an alternative to measures required by accounting principles generally accepted in the United States. Our calculations of these measures may differ from calculations of similar measures used by other companies and you should be careful when comparing these financial measures to those of other companies. Additional information regarding these financial measures, including reconciliations of each non- GAAP financial measure, is available in the subsection of MD&A titled, "Non-GAAP Financial Measures."

REVENUES- DEFINED

As required by Regulation S-X, we separately present revenues generated as either product revenues or service revenues on our Consolidated Statements of Income for each period presented. When we discuss revenues, we may, at times, refer to revenues summarized differently than the Regulation S-X requirements. The terminology, definitions, and applications of terms


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that we use to describe revenues may be different from terms used by other companies. We use the following terms to describe revenues:

• Revenues - Our revenues are presented net of sales returns and allowances.

• Product Revenues - We define product revenues as revenues generated from sales of consumable and capital equipment products.

• Service Revenues - We define service revenues as revenues generated from parts and labor associated with the maintenance, repair, and installation of our capital equipment. Service revenues also include hospital sterilization services, instrument and scope repairs, and linen management as well as revenues generated from contract sterilization and laboratory services offered through our Applied Sterilization Technologies segment.

• Capital Revenues - We define capital revenues as revenues generated from sales of capital equipment, which includes steam sterilizers, low temperature liquid chemical sterilant processing systems, including SYSTEM 1 and 1E, washing systems, VHP® technology, water stills, and pure steam generators; surgical lights and tables; and integrated OR.

• Consumable Revenues - We define consumable revenues as revenues generated from sales of the consumable family of products, which includes SYSTEM 1 and 1E consumables, V-Pro consumables, gastrointestinal endoscopy accessories, sterility assurance products, skin care products, cleaning consumables, and surgical instruments.

• Recurring Revenues - We define recurring revenues as revenues generated from sales of consumable products and service revenues.

GENERAL OVERVIEW AND EXECUTIVE SUMMARY

Our Business. STERIS plc, a public limited company organized under the laws of England and Wales, was incorporated on October 9, 2014 as a private limited company under the name New STERIS Limited and was re-registered effective November 2, 2015 as a public limited company under the name STERIS plc. New STERIS Limited was established to effect the combination ("Combination") of STERIS Corporation, an Ohio corporation ("Old STERIS"), and Synergy Health plc, a public limited company organized under the laws of England and Wales ("Synergy"). The Combination closed on November 2, 2015 and as a result STERIS plc became the ultimate parent company of Old STERIS and STERIS completed the acquisition of Synergy in a cash and stock transaction. Synergy has been re-registered under the name Synergy Health Limited. The Combination was accounted for in the consolidated financial statements as a merger between entities under common control; accordingly the historical consolidated financial statements of Old STERIS for periods prior to November 2, 2015, are considered to be the historical financial statements of STERIS plc.
Due to the timing of the closing of the Combination, the results of Synergy are only reflected in the results of operations of the Company from November 2, 2015 forward, which will affect comparability to the prior period historical operations of the Company throughout this Annual Report on Form 10-K. As a result of the Combination, we have reorganized our operations into four reportable business segments: Healthcare Products, Healthcare Specialty Services, Life Sciences, and Applied Sterilization Technologies. We describe our business segments in note 12 to our consolidated financial statements, titled "Business Segment Information."
Our mission is to help our Customers create a healthier and safer world by providing innovative healthcare and life science product and service solutions around the globe. Our dedicated employees around the world work together to supply a broad range of solutions by offering a combination of capital equipment, consumables, and services to healthcare, pharmaceutical, industrial, and governmental Customers.
The bulk of our revenues are derived from the healthcare and pharmaceutical industries. Much of the growth in these industries is driven by the aging of the population throughout the world, as an increasing number of individuals are entering their prime healthcare consumption years, and is dependent upon advancement in healthcare delivery, acceptance of new technologies, government policies, and general economic conditions. The pharmaceutical industry has been impacted by increased FDA scrutiny of cleaning and validation processes, mandating that manufacturers improve their processes. Within healthcare, there is increased concern regarding the level of hospital acquired infections around the world; increased demand for medical procedures, including preventive screenings such as endoscopies and colonoscopies; and a desire by our Customers to operate more efficiently, all which are driving increased demand for many of our products and services.
We also are pursuing a strategy of expanding into adjacent markets with acquisitions in the Healthcare Products, Healthcare Specialty Services and Life Sciences segments. On July 31, 2015 we acquired all of the outstanding shares of General Econopak, Inc. ("Gepco"), a Pennsylvania-based manufacturer of consumable product solutions in the areas of sterility maintenance, barrier protection, and sterile cleanroom products for pharmaceutical, biotechnology and veterinary Customers. On June 12, 2015 we acquired the capital stock of Black Diamond Video, Inc. ("Black Diamond"), a California-based developer and provider of operating room integration systems. We also completed several other minor purchases that continued to expand our service offerings in the Healthcare Products, Healthcare Specialty Services and Life Sciences segments.


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We continue to invest in manufacturing in-sourcing projects for the purpose of improving quality, cost and delivery of our products to our Customers.

Highlights. Revenues increased $388.5 million, or 21.0%, to $2,238.8 million for the year ended March 31, 2016, as compared to $1,850.3 million for the year ended March 31, 2015, reflecting growth within all four business segments and the Combination with Synergy.
Fiscal 2016 operating income decreased 6.3% to $212.9 million over the fiscal 2015 operating income of $227.2 million. Contributing to this decrease were additional acquisition costs related to our Combination with Synergy of $50.1 million, in fiscal 2016 over fiscal 2015. In addition, we incurred $26.5 million in the second quarter of fiscal 2016 in connection with a settlement of a legacy pension obligation (see Note 10 to our financial statements titled ,"Benefit Plans" for more information).
Net cash flows from operations were $254.7 million and free cash flow was $129.1 million in fiscal 2016 compared to Net cash flows from operations of $246.0 and free cash flow of $161.6 in fiscal 2015, (see subsection of MD&A titled, "Non-GAAP Financial Measures" for additional information and related reconciliation of non-GAAP financial measures to the most comparable GAAP measures). Cash flow from operations and free cash flow were negatively impacted by expenses related to the Combination with Synergy and other acquisitions. In addition, the amount paid in fiscal 2016 in connection with our annual compensation program was higher than the amount paid in fiscal 2015 and a pension contribution was made in connection with the settlement of a legacy pension obligation (see Note 8 to our financial statements titled,"Benefit Plans" for more information on the pension obligation settlement). Free cash flow was further impacted by an increase in purchases of property, plant, equipment and intangibles. Our debt-to-total capital ratio was 34.2% at March 31, 2016. We increased our quarterly dividend for the tenth consecutive year to $0.25 per share per quarter.
Outlook. Fluctuations in foreign currency rates can impact revenues and costs outside of the United States, creating variability in our results for fiscal 2016 and beyond.
In fiscal 2017 and beyond, we expect to continue to manage our costs, grow our business with internal product and service development, invest in greater capacity, and augment these value creating methods with acquisitions of adjacent products and services. We plan to continue our efforts to in-source some of the production that we have traditionally out-sourced.

MATTERS AFFECTING COMPARABILITY

International Operations. Through our subsidiaries, we operate in various international locations. Fluctuations in the exchange rate of our reporting currency, the U.S. dollar, relative to the currencies of other countries in which we operate can increase or decrease our reported net assets and results of operations. During fiscal 2016, our revenues were unfavorably impacted by $41.9 million, or 1.8%, and income before taxes was favorably impacted by $20.4 million, or 13.6%, as a result of foreign currency movements relative to the U.S. dollar.

NON-GAAP FINANCIAL MEASURES

We, at times, refer to financial measures which are considered to be "non-GAAP financial measures" under SEC rules. We, at times, also refer to our results of operations excluding certain transactions or amounts that are non-recurring or are not indicative of future results, in order to provide meaningful comparisons between the periods presented.
These non-GAAP financial measures are not intended to be, and should not be, considered separately from or as an alternative to the most directly comparable GAAP financial measures.
These non-GAAP financial measures are presented with the intent of providing greater transparency to supplemental financial information used by management and the Board of Directors in their financial analysis and operational decision-making. These amounts are disclosed so that the reader has the same financial data that management uses with the belief that it will assist investors and other readers in making comparisons to our historical operating results and analyzing the underlying performance of our operations for the periods presented.
We believe that the presentation of these non-GAAP financial measures, when considered along with our GAAP financial measures and the reconciliation to the corresponding GAAP financial measures, provide the reader with a more complete understanding of the factors and trends affecting our business than could be obtained absent this disclosure. It is important for the reader to note that the non-GAAP financial measure used may be calculated differently from, and therefore may not be comparable to, a similarly titled measure used by other companies.
We define free cash flow as net cash provided by operating activities as presented in the Consolidated Statements of Cash Flows less purchases of property, plant, equipment, and intangibles plus proceeds from the sale of property, plant, equipment,


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and intangibles, which are also presented in the Consolidated Statements of Cash Flows. We use this as a measure to gauge our ability to fund future debt principal repayments and growth outside of core operations, repurchase shares, and pay cash dividends. The following table summarizes the calculation of our free cash flow for the years ended March 31, 2016, 2015 and 2014:

                                                                Years Ended March 31,
(dollars in thousands)                                    2016          2015          2014
Net cash flows provided by operating activities        $ 254,675     $ 246,040     $ 209,631
Purchases of property, plant, equipment and
intangibles, net                                        (126,407 )     (85,255 )     (86,367 )
Proceeds from the sale of property, plant, equipment
and intangibles                                              844           829         4,774
Free cash flow                                         $ 129,112     $ 161,614     $ 128,038

RESULTS OF OPERATIONS

In the following subsections, we discuss our earnings and the factors affecting them. We begin with a general overview of our operating results and then separately discuss earnings for our operating segments.

FISCAL 2016 AS COMPARED TO FISCAL 2015

Revenues. The following table compares our revenues, in total and by type and
geography, for the year ended March 31, 2016 to the year ended March 31, 2015:

                              Years Ended March 31,                   Percent
(dollars in thousands)         2016           2015         Change      Change
Total revenues             $ 2,238,764    $ 1,850,263    $ 388,501      21.0 %

Revenues by type:
Capital equipment revenues     613,904        597,809       16,095       2.7 %
Consumable revenues            516,142        449,996       66,146      14.7 %
Service revenues             1,108,718        802,458      306,260      38.2 %

Revenues by geography:
United Kingdom revenues        144,577         51,889       92,688     178.6 %
United States revenues       1,662,050      1,449,223      212,827      14.7 %
Other foreign revenues         432,137        349,151       82,986      23.8 %

Revenues increased $388.5 million, or 21.0%, to $2,238.8 million for the year ended March 31, 2016, as compared to $1,850.3 million for the year ended March 31, 2015. This increase is attributable to the Combination, along with growth within all reportable business segments. Recent acquisitions contributed 16.4% and impacted all three revenue types.
Capital equipment revenues increased by $16.1 million, or 2.7%, to $613.9 million, during fiscal 2016 as compared to fiscal 2015. This increase was driven by growth within the Healthcare Products and Life Sciences business segments. Geographically, the North American region was strong with 9% growth offset by declines in other regions. Consumable revenues increased $66.1 million, or 14.7%, during fiscal 2016 from fiscal 2015. Consumable revenues grew in both the Healthcare Product and Life Sciences business segments and experienced growth in all regions. Service revenues for fiscal 2016 increased $306.3 million, or 38.2%, over fiscal 2015 driven by the continued expansion of service offerings and the Combination with Synergy. In addition, all reportable segments also experienced organic service revenue growth.
United Kingdom revenues for fiscal 2016 were $144.6 million, an increase of $92.7 million, or 178.6%, over fiscal 2015 revenues of $51.9 million. This increase reflects growth in both consumable and service revenues due primarily to the Combination with Synergy, partially offset by a decline in capital equipment revenues.


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United States revenues for fiscal 2016 were $1,662.1 million, an increase of $212.8 million, or 14.7%, over fiscal 2015 revenues of $1,449.2 million. This increase reflects growth in capital equipment, consumable and service revenues. Revenues from other foreign locations for fiscal 2016 were $432.1 million, an increase of 23.8% over the fiscal 2015 revenues of $349.2 million. This increase reflects revenue growth within the rest of EMEA and the Asia Pacific region which were partially offset by declines within the Latin America region and Canada.

Gross Profit. The following table compares our gross profit for the year ended March 31, 2016 to the year ended March 31, 2015:

                                 Years Ended March 31,                   Percent
(dollars in thousands)            2016           2015         Change      Change
Gross profit:
Product                       $   511,885     $ 463,595     $  48,290      10.4 %
Service                           383,596       310,706        72,890      23.5 %
Total gross profit            $   895,481     $ 774,301     $ 121,180      15.7 %
Gross profit percentage:
Product                              45.3 %        44.2 %
Service                              34.6 %        38.7 %
Total gross profit percentage        40.0 %        41.8 %

Our gross profit is affected by the volume, pricing and mix of sales of our products and services, as well as the costs associated with the products and services that are sold. Our gross profit increased $121.2 million and gross profit percentage decreased 180 basis points to 40.0% for fiscal 2016 as compared to 41.8% for fiscal 2015. Although our recent acquisitions expanded our gross profit, they negatively impacted our gross margin percentage by approximately 290 basis points. As anticipated, the addition of Synergy's hospital sterilization services and linen management businesses is a key factor in the declines in gross margin percentages. We have applied our "four walls" approach to the operation of Synergy, which reports all direct and indirect costs related to the delivery of services as costs of goods sold. This approach caused additional costs to be included in costs of goods sold rather than in selling, general and administrative costs as Synergy would have previously reported. Our gross profit percentage was impacted positively by foreign currency fluctuations (120 basis points.) Other factors such as favorable pricing, productivity and material costs served to offset inflation and the negative impact of product mix shift (10 basis points).

Operating Expenses. The following table compares our operating expenses for the year ended March 31, 2016 to the year ended March 31, 2015:

                                          Years Ended March 31,                    Percent
(dollars in thousands)                     2016           2015         Change       Change
Operating expenses:
Selling, general, and administrative   $   626,710     $ 493,342     $ 133,368       27.0 %
Research and development                    56,664        54,139         2,525        4.7 %
Restructuring expenses                        (820 )        (391 )        (429 )       NM
Total operating expenses               $   682,554     $ 547,090     $ 135,464       24.8 %

NM - Not meaningful

Significant components of total selling, general, and administrative expenses ("SG&A") are compensation and benefit costs, fees for professional services, travel and entertainment, facilities costs, and other general and administrative expenses. SG&A increased 27.0% in fiscal 2016 over fiscal 2015. Contributing to this increase was additional acquisition and integration costs related to recent acquisitions, including Synergy, of $50.1 million over the prior year period. Higher amortization of acquired intangible assets also contributed to the increase in SG&A in both periods. In addition, we incurred $26.5 million in the second quarter of fiscal 2016 in connection with the settlement of a legacy pension obligation (see Note 10 to our financial statements titled, "Benefit Plans" for more information).
Research and development expenses increased $2.5 million during fiscal 2016, as compared to fiscal 2015. The increase in fiscal 2016 is attributable to additional spending in connection with the development of healthcare products and accessories. Research and development expenses are influenced by the number and timing of in-process projects and labor hours and other


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costs associated with these projects. Our research and development initiatives continue to emphasize new product development, product improvements, and the development of new technological platform innovations. During fiscal 2016, our investments in research and development continued to be focused on, but were not limited to, enhancing capabilities of sterile processing combination technologies, procedural products and accessories, and devices and support accessories used in gastrointestinal endoscopy procedures.
Restructuring Expenses. We recognize restructuring expenses as they are incurred. We also evaluate the inventory and property, plant and equipment associated with our restructuring actions for impairment. Asset impairment and accelerated depreciation expenses primarily relate to inventory write-downs for rationalized products and adjustments in the carrying value of the closed facilities to their estimated fair value. In addition, the remaining useful lives of other property, plant and equipment associated with the related operations were re-evaluated based on the respective plan, resulting in the acceleration of depreciation and amortization of certain assets. Fiscal 2014 Restructuring Plan. During the fourth quarter of fiscal 2014, we adopted and announced a targeted restructuring plan primarily focused on the closure of the Hopkins manufacturing facility located in Mentor, Ohio (the "Fiscal 2014 Restructuring Plan"). We believe that by closing the operations at Hopkins we will more effectively utilize our existing North American manufacturing network while reducing operating costs. We have incurred pre-tax expenses totaling $19.0 million related to these actions, of which $10.9 million was recorded as restructuring expenses and $8.1 million was recorded in cost of revenues, with restructuring expenses of $15.6 million, $1.3 million, $0.8 million, and $1.3 million related to the Healthcare Products, Healthcare Specialty Services, Life Sciences and Applied Sterilization Technologies segments, respectively.
Fiscal 2010 Restructuring Plan. During the fourth quarter of fiscal 2010 we adopted a restructuring plan primarily related to the transfer of the remaining operations in our Erie, Pennsylvania facility to the U.S. headquarters in Mentor, Ohio and the consolidation of our European Healthcare manufacturing operations into two central locations within Europe (the "Fiscal 2010 Restructuring Plan"). In addition, we rationalized certain products and eliminated certain positions. Since the inception of the Fiscal 2010 Restructuring Plan, we have incurred pre-tax expenses totaling $9.3 million related to these actions, of which $8.2 million was recorded as restructuring expenses and $1.1 million was recorded in cost of revenues. We do not expect to incur any significant additional restructuring expenses related to this plan. These actions are intended to enhance profitability and improve efficiencies. For more information regarding our Restructuring activities please refer to note 2 of our consolidated financial statements titled, "Restructuring". Non-Operating Expenses, Net. Non-operating expense (income), net consists of interest expense on debt, offset by interest earned on cash, cash equivalents, short-term investment balances, and other miscellaneous expense. The following table compares our non-operating expense (income), net for the year ended March 31, 2016 to the year ended March 31, 2015:

                                               Years Ended March 31,
(dollars in thousands)                           2016           2015        Change
Non-operating expenses, net:
Interest expense                            $    42,708      $ 19,187     $ 23,521
Interest income and miscellaneous expense        (1,665 )        (796 )       (869 )
Non-operating expenses, net                 $    41,043      $ 18,391     $ 22,652

Interest expense during fiscal 2016 increased due to higher interest costs resulting from our May 2015 issuance of senior notes in a private placement offering, additional borrowings under our credit facilities to fund . . .

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