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STE > SEC Filings for STE > Form 10-Q on 8-Nov-2016All Recent SEC Filings

Show all filings for STERIS PLC

Form 10-Q for STERIS PLC


8-Nov-2016

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Introduction

In Management's Discussion and Analysis of Financial Condition and Results of Operations (the "MD&A"), we explain the general financial condition and the results of operations for STERIS including:

• what factors affect our business;

• what our earnings and costs were in each period presented;

• why those earnings and costs were different from prior periods;

• 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, repurchases of shares, pay cash dividends and fund future working capital needs.

As you read the MD&A, it may be helpful to refer to information in our consolidated financial statements, which present the results of our operations for the second quarter and first half of fiscal 2017 and fiscal 2016. It may also be helpful to read the MD&A in our Annual Report on Form 10-K for the year ended March 31, 2016, dated May 31, 2016. In the MD&A, we analyze and explain the period-over-period changes in the specific line items in the Consolidated Statements of Income. Our analysis 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 other 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 that we use to describe revenues may be different from terms used by other companies. We use the following terms to describe revenues:


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• 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, surgical instruments, and barrier products.

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

General Company Overview and Executive Summary 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 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 the England and Wales ("Synergy"). This Combination closed on November 2, 2015 and as a result STERIS plc became the ultimate parent company of Old STERIS and Synergy. 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 quarterly report on Form 10-Q. 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 10 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, medical devices 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. In addition, each of our core industries is experiencing specific trends that could increase demand. Within healthcare, there is increased concern regarding the level of hospital-acquired infections around the world. The pharmaceutical industry has been impacted by increased FDA scrutiny of cleaning and validation processes, mandating that manufacturers improve their processes. The aging population increases the demand for medical procedures, which increases the consumption of single use medical devices and surgical kits processed by our Applied Sterilization Technologies segment.
We are actively pursuing new opportunities to adapt our proven technologies to meet the changing needs of the global marketplace. We are also executing on our strategic initiatives by expanding into adjacent markets with acquisitions, divesting non-core assets and integrating Synergy. During the quarter, we divested our Applied Infection Control ("AIC") product line (annual revenues of approximately $50 million) and two businesses acquired in the Combination with Synergy: UK Linen Management Services business (annual revenues of approximately $50 million) and Synergy Health Laboratory Services (annual revenues of approximately $15 million). Subsequent to the end of the fiscal 2017 second quarter, we also sold the assets associated with linen management services in the United States (annual revenues of approximately $50 million) that was also acquired in the Combination with Synergy.


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Fiscal 2017 second quarter revenues were $646.4 million, representing an increase of 31.9% over the fiscal 2016 second quarter revenues of $489.9 million, reflecting growth within all reportable business segments including growth resulting from the Combination. Fiscal 2017 first half revenues were $1,284.8 million representing an increase of 38.2% over the first half of fiscal 2016 revenues of $929.8 million, also reflecting growth within all four business segments including growth resulting from the Combination.
Fiscal 2017 second quarter gross margin percentage was 38.4% compared with 42.7% for the fiscal 2016 second quarter. 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. During the first half of fiscal 2017, gross margin percentage was 38.0% compared with 42.3% for the first half of fiscal 2016 primarily due to the Combination. 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.
Fiscal 2017 second quarter operating income was $69.6 million, compared to fiscal 2016 second quarter operating income of $22.7 million. During the first half of fiscal 2017, operating income was $143.1 million, compared to $66.9 million for the first half of fiscal 2016. The year over year increase is attributable to recent acquisitions, including the Combination and lower acquisition related expenses, partially offset by the net loss recognized on the divestiture of certain non-core assets.

Cash flows from operations were $188.5 million and free cash flow was $119.4 million in the first six months of fiscal 2017 compared to cash flows from operations of $79.5 million and free cash flow $39.6 million in the first six months of fiscal 2016, respectively (see the subsection below titled "Non-GAAP Financial Measures" for additional information and related reconciliation of cash flows from operations to free cash flow). The higher cash flow from operations and free cash flow as compared to the prior year period are primarily due to a reduction in acquisition related expenses and higher net income. Our debt-to-total capital ratio was 33.4% at September 30, 2016 and 34.2% at March 31, 2016. During the first six months of fiscal 2017, we declared and paid quarterly cash dividends of $0.53 per ordinary share.
Additional information regarding our financial performance during the fiscal second quarter and first six months of 2017 is included in the subsection below titled "Results of Operations."

Matters Affecting Comparability

International Operations. Since we conduct operations outside of the United States using various foreign currencies, our operating results are impacted by foreign currency movements relative to the U.S. dollar. During the second quarter of fiscal 2017, our revenues were unfavorably impacted by $3.2 million, or 0.6%, and income before taxes was favorably impacted by $1.6 million, or 1.7%, as a result of foreign currency movements relative to the U.S. dollar. During the first half of fiscal 2017, our revenues were unfavorably impacted by $4.9 million, or 0.5%, and income before taxes was favorably impacted by $4.4 million, or 3.0%, 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, growth outside of core operations, repurchase shares, and pay cash dividends.

The following table summarizes the calculation of our free cash flow for the six month periods ended September 30, 2016 and 2015:

                                                                    Six Months Ended September 30,
(dollars in thousands)                                                  2016                2015
Net cash provided by operating activities                        $       188,501       $      79,472
Purchases of property, plant, equipment and intangibles, net             (73,866 )           (39,928 )
Proceeds from the sale of property, plant, equipment and
intangibles                                                                4,763                  38
Free cash flow                                                   $       119,398       $      39,582

Results of Operations

In the following subsections, we discuss our earnings and the factors affecting them for the second quarter and first half of fiscal 2017 compared with the same fiscal 2016 period. We begin with a general overview of our operating results and then separately discuss earnings for our operating segments.

Revenues. The following tables compare our revenues for the three and six months ended September 30, 2016 to the revenues for the three and six months ended September 30, 2015:

                                       Three Months Ended September
                                                   30,
(dollars in thousands)                     2016            2015          Change       Percent Change

Total revenues                         $   646,415     $  489,897     $  156,518             31.9 %

Revenues by type:
Capital equipment revenues                 152,640        152,038            602              0.4 %
Consumable revenues                        139,576        122,107         17,469             14.3 %
Service revenues                           354,199        215,752        138,447             64.2 %

Revenues by geography:
United Kingdom revenues                     53,369         11,746         41,623            354.4 %
United States revenues                     450,513        395,220         55,293             14.0 %
Other foreign revenues                     142,533         82,931         59,602             71.9 %


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                                        Six Months Ended September
                                                    30,
(dollars in thousands)                      2016            2015          Change       Percent Change

Total revenues                         $  1,284,793     $  929,799     $  354,994             38.2 %

Revenues by type:
Capital equipment revenues                  278,725        270,258          8,467              3.1 %
Consumable revenues                         285,241        236,194         49,047             20.8 %
Service revenues                            720,827        423,347        297,480             70.3 %

Revenues by geography:
United Kingdom revenues                     123,808         21,915        101,893            464.9 %
United States revenues                      878,618        755,689        122,929             16.3 %
Other foreign revenues                      282,367        152,196        130,171             85.5 %

Quarter over Quarter Comparison

Revenues increased $156.5 million, or 31.9%, to $646.4 million for the quarter ended September 30, 2016, as compared to $489.9 million for the same quarter in the prior year. This increase is attributable to recent acquisitions including the Combination with Synergy along with organic growth in all reportable business segments.

Capital equipment revenues increased 0.4% in the second quarter of fiscal 2017, as compared to the second quarter of fiscal 2016 with strength in the Life Science segment partially offset by softness in the Healthcare Products segment. Consumable revenues increased 14.3% for the quarter ended September 30, 2016, as compared to the prior year quarter, primarily due to recent acquisitions, along with organic growth in both the Healthcare Products and Life Sciences segments. Service revenues increased 64.2% in the second quarter of fiscal 2017 driven by the Combination with Synergy and organic growth in all reportable business segments.

United Kingdom revenues increased $41.6 million, or 354.4%, to $53.4 million for the quarter ended September 30, 2016, as compared to $11.7 million for the same prior year quarter. This increase reflects growth in capital, consumable and service revenues and is primarily attributable to the Combination with Synergy. United States revenues increased $55.3 million, or 14.0%, to $450.5 million for the quarter ended September 30, 2016, as compared to $395.2 million for the same prior year quarter. This increase reflects year over year growth of 6.1%, 5.5% and 22.5% in capital equipment, consumable, and service revenues, respectively. The increases are attributable to acquisitions, including the Combination with Synergy, as well as organic growth.

Revenue from other foreign locations increased $59.6 million, or 71.9%, to $142.5 million for the quarter ended September 30, 2016, as compared to $82.9 million for the same prior year quarter. This increase reflects growth in the EMEA outside of the United Kingdom, as well as in the Asia Pacific and Latin American regions. The Combination with Synergy was a significant driver of the growth in the EMEA outside of the United Kingdom.

First Half over First Half Comparison

Revenues increased $355.0 million, or 38.2%, to $1,284.8 million for the six months ended September 30, 2016, as compared to $929.8 million for the same period in the prior year. This increase is primarily attributable to recent acquisitions including the Combination with Synergy but also reflects organic growth in all reportable business segments.

Capital equipment revenues increased 3.1% in the first six months of fiscal 2017, as compared to the same period in fiscal 2016. Most of the capital equipment revenues increase was in the United States although revenues also increased in the EMEA. Consumable revenues increased 20.8% for the six months ended September 30, 2016, as compared to the same period in the prior year, due, in part, to recent acquisitions, but also strong growth in both the Healthcare Products and Life Sciences segments. Service revenues increased 70.3% in the first half of fiscal 2017 driven by the Combination with Synergy and organic growth in all reportable business segments.


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United Kingdom revenues increased $101.9 million, or 464.9%, to $123.8 million for the six months ended September 30, 2016, as compared to $21.9 million for the same period in the prior year. This increase reflects growth in capital, consumable and service revenues and is primarily attributable to the Combination with Synergy.
United States revenues increased $122.9 million, or 16.3%, to $878.6 million for the six months ended September 30, 2016, as compared to $755.7 million for the same period in the prior year. This increase reflects year over year growth of 6.2%, 12.1% and 23.3% in capital equipment, consumable and service revenues, respectively. The increases are attributable to acquisitions, including the Combination with Synergy, as well as organic growth.

Revenue from other foreign locations increased $130.2 million, or 85.5%, to $282.4 million for the six months ended September 30, 2016, as compared to $152.2 million for the same period in the prior year. This increase reflects growth in the EMEA outside of the United Kingdom, as well as in the Asia Pacific and Latin American regions. The Combination with Synergy was a significant driver of the growth in the EMEA outside of the United Kingdom.

Gross Profit. The following table compares our gross profit for the three months and six months ended September 30, 2016 to the three months and six months ended September 30, 2015:

                                   Three Months Ended September 30,                   Percent
(dollars in thousands)                 2016                 2015           Change      Change
Gross profit:
Product                         $       137,106       $       126,057     $ 11,049       8.8 %
Service                                 110,802                83,264       27,538      33.1 %
Total gross profit              $       247,908       $       209,321     $ 38,587      18.4 %
Gross profit percentage:
Product                                    46.9 %                46.0 %
Service                                    31.3 %                38.6 %
Total gross profit percentage              38.4 %                42.7 %


                                    Six Months Ended
                                      September 30,                     Percent
(dollars in thousands)             2016          2015        Change      Change
Gross profit:
Product                         $ 266,157     $ 228,508     $ 37,649      16.5 %
Service                           221,741       164,903       56,838      34.5 %
Total gross profit              $ 487,898     $ 393,411     $ 94,487      24.0 %
Gross profit percentage:
Product                              47.2 %        45.1 %
Service                              30.8 %        39.0 %
Total gross profit percentage        38.0 %        42.3 %

Our gross profit percentage 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. Gross profit increased $38.6 million and declined 430 basis points as a percentage of revenues in the fiscal 2017 second quarter as compared to the fiscal 2016 second quarter. Our gross profit percentage was negatively impacted by the addition of Synergy's hospital sterilization services and linen management business (440 basis points), partially offset by the favorable impacts of the suspension of the Medical Device Excise Tax (40 basis points), foreign currency rate movements (30 basis points), and pricing and divestitures (20 basis points). 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.
Gross profit percentage for the first half of fiscal 2017 was 38.0% compared to the gross profit percentage in the first half of fiscal 2016 of 42.3%. The gross profit percentage decreased 430 basis points in the first half of fiscal 2017 over fiscal 2016. Our gross profit percentage was negatively impacted by the addition of Synergy's hospital sterilization services and linen management business (500 basis points), partially offset by the positive impact of foreign currency (40 basis points) and the suspension of the Medical Device Excise Tax (40 basis points).


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Operating Expenses. The following table compares our operating expenses for the three months and six months ended September 30, 2016 to the three months and six months ended September 30, 2015:

                                                     Three Months Ended
                                                       September 30,                        Percent
(dollars in thousands)                               2016          2015         Change       Change
Operating expenses:
Selling, general, and administrative             $  163,680     $ 172,459     $ (8,779 )      (5.1 )%
. . .
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