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STE > SEC Filings for STE > Form 10-Q on 8-Feb-2017All Recent SEC Filings

Show all filings for STERIS PLC

Form 10-Q for STERIS PLC


8-Feb-2017

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 third quarter and first nine months 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 ("Parent") was organized in 2014 under the name Solar New HoldCo Limited as a private limited company for the purpose of effecting under the laws of England and Wales 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"). Effective November 2, 2015 the Parent was re-registered as a public company under the name STERIS plc and the Combination closed. As a result of the Combination closing, STERIS plc became the ultimate parent company of Old STERIS and Synergy. Synergy has been re-registered under the name of Synergy Health Limited. The acquisition of Old STERIS 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 first nine months of fiscal 2017, we divested our Applied Infection Control ("AIC") product line (annual revenues of approximately $50 million) and three businesses acquired in the Combination with Synergy: UK Linen Management Services business (annual revenues of approximately $50 million), US Linen Management Services business (annual revenues of approximately $50 million), and Synergy Health Laboratory Services (annual revenues of approximately $15 million).


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Fiscal 2017 third quarter revenues were $646.8 million, representing an increase of 4.5% over the fiscal 2016 third quarter revenues of $618.7 million. This increase was primarily attributable to recent acquisitions including the Combination with Synergy along with organic revenue growth in three of our four reportable business segments, partially offset by divestitures and the negative impact of foreign currency. Revenues for the first nine months of fiscal 2017 were $1,931.6 million representing an increase of 24.7% over the first nine months of fiscal 2016 revenues of $1,548.5 million, reflecting growth within all four business segments including growth resulting from the Combination, partially offset by divestitures and the negative impact of foreign currency. Fiscal 2017 third quarter gross margin percentage was 39.8% compared with 38.5% for the fiscal 2016 third quarter. The increase was primarily due to divestitures of certain lower margin operations and the positive impact of foreign currency, partially offset by the addition of Synergy's hospital sterilization services and linen management businesses. During the first nine months of fiscal 2017, gross margin percentage was 38.6% compared with 40.8% for the first nine months of fiscal 2016 primarily due to the Combination. We have applied our "four walls" approach to the operations 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 third quarter operating income was $25.9 million, compared to fiscal 2016 third quarter operating income of $46.7 million. The decrease was primarily due to the goodwill impairment loss relative to the Synergy Health Netherlands linen management unit recorded in the third quarter of fiscal 2017. During the first nine months of fiscal 2017, operating income was $169.0 million, compared to $113.6 million for the first nine months of fiscal 2016. The year over year increase is attributable to growth, margin improvements, recent acquisitions, including the Combination and lower acquisition related expenses, partially offset by the goodwill impairment loss and the net loss recognized on the divestiture of certain non-core assets.

Cash flows from operations were $289.4 million and free cash flow was $182.0 million in the first nine months of fiscal 2017 compared to cash flows from operations of $104.6 million and free cash flow $22.9 million in the first nine 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 higher net income and a reduction in acquisition related expenses. Our debt-to-total capital ratio was 35.3% at December 31, 2016 and 34.2% at March 31, 2016. During the first nine months of fiscal 2017, we declared and paid quarterly cash dividends of $0.81 per ordinary share.
Additional information regarding our financial performance during the fiscal third quarter and first nine 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 third quarter of fiscal 2017, our revenues were unfavorably impacted by $10.2 million, or 1.6%, and income before taxes was favorably impacted by $11.5 million as a result of foreign currency movements relative to the U.S. dollar. During the first nine months of fiscal 2017, our revenues were unfavorably impacted by $15.2 million, or 0.8%, and income before taxes was favorably impacted by $16.4 million 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


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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, 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 nine month periods ended December 31, 2016 and 2015:

                                                                     Nine Months Ended December 31,
(dollars in thousands)                                                  2016                 2015
Net cash provided by operating activities                        $       289,405       $       104,619
Purchases of property, plant, equipment and intangibles, net            (112,225 )             (82,117 )
Proceeds from the sale of property, plant, equipment and
intangibles                                                                4,785                   400
Free cash flow                                                   $       181,965       $        22,902

Results of Operations

In the following subsections, we discuss our earnings and the factors affecting them for the third quarter and first nine months 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 nine months ended December 31, 2016 to the revenues for the three and nine months ended December 31, 2015:

                                        Three Months Ended December 31,
(dollars in thousands)                        2016              2015          Change       Percent Change

Total revenues                         $        646,774     $  618,688     $   28,086            4.5  %

Revenues by type:
Capital equipment revenues                      168,804        167,815            989            0.6  %
Consumable revenues                             133,456        137,340         (3,884 )         (2.8 )%
Service revenues                                344,514        313,533         30,981            9.9  %

Revenues by geography:
United Kingdom revenues                          52,316         51,468            848            1.6  %
United States revenues                          447,573        438,250          9,323            2.1  %
Other foreign revenues                          146,885        128,970         17,915           13.9  %


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                                         Nine Months Ended December 31,
(dollars in thousands)                        2016              2015           Change       Percent Change

Total revenues                         $      1,931,567     $ 1,548,487     $  383,080             24.7 %

Revenues by type:
Capital equipment revenues                      447,529         438,074          9,455              2.2 %
Consumable revenues                             418,697         373,534         45,163             12.1 %
Service revenues                              1,065,341         736,879        328,462             44.6 %

Revenues by geography:
United Kingdom revenues                         176,124          73,382        102,742            140.0 %
United States revenues                        1,326,190       1,193,940        132,250             11.1 %
Other foreign revenues                          429,253         281,165        148,088             52.7 %

Quarter over Quarter Comparison

Revenues increased $28.1 million, or 4.5%, to $646.8 million for the quarter ended December 31, 2016, as compared to $618.7 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 three of our four reportable business segments, partially offset by divestitures and the negative impact of foreign currency.

Capital equipment revenues were relatively flat, increasing 0.6% in the third quarter of fiscal 2017, as compared to the third quarter of fiscal 2016. Healthcare Product capital equipment revenues grew 5.7%, but were largely offset by a 28.5% decline in Life Sciences revenue. Consumable revenues decreased 2.8% for the quarter ended December 31, 2016, as compared to the prior year quarter, as 3.7% growth within the Life Sciences segment was more than offset by a decline in the Healthcare Products segment due primarily to the sale of the AIC product line. Service revenues increased 9.9% in the third quarter of fiscal 2017 driven by the Combination with Synergy and organic growth in all reportable business segments.

United Kingdom revenues increased $0.8 million, or 1.6%, to $52.3 million for the quarter ended December 31, 2016, as compared to $51.5 million for the same prior year quarter despite the negative impact of foreign currency. This increase reflects growth in capital equipment and consumable revenues and is primarily attributable to acquisitions. Service revenues declined as the impact of divestitures more than offset growth in other businesses.
United States revenues increased $9.3 million, or 2.1%, to $447.6 million for the quarter ended December 31, 2016, as compared to $438.3 million for the same prior year quarter. This increase reflects year over year growth of 3.3% and 4.6% in capital equipment and service revenues, respectively. The increases are attributable to acquisitions, including the Combination with Synergy, as well as organic growth. Consumable revenues in the United States declined 4.8% primarily due to the sale of the AIC product line.

Revenue from other foreign locations increased $17.9 million, or 13.9%, to $146.9 million for the quarter ended December 31, 2016, as compared to $129.0 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 region offset by a slight decline in the Latin American region. The Combination with Synergy was a key driver of the growth in the EMEA outside of the United Kingdom.

First Nine Months over First Nine Months Comparison

Revenues increased $383.1 million, or 24.7%, to $1,931.6 million for the nine months ended December 31, 2016, as compared to $1,548.5 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, partially offset by divestitures and the negative impact of foreign currency.


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Capital equipment revenues increased 2.2% in the first nine months of fiscal 2017, as compared to the same period in fiscal 2016. Growth in the United States and United Kingdom was partially offset by declines in other foreign regions. Consumable revenues increased 12.1% for the nine months ended December 31, 2016, as compared to the same period in the prior year. This increase was due, in part, to recent acquisitions, but also strong growth in both the Healthcare Products and Life Sciences segments, partially offset by the sale of the AIC product line. Service revenues increased 44.6% in the first nine months of fiscal 2017 driven by the Combination with Synergy and organic growth in all reportable business segments.

United Kingdom revenues increased $102.7 million, or 140.0%, to $176.1 million for the nine months ended December 31, 2016, as compared to $73.4 million for the same period in the prior year despite the negative impact of foreign currency. This increase reflects growth in capital equipment, consumable and service revenues and is primarily attributable to the Combination with Synergy. United States revenues increased $132.3 million, or 11.1%, to $1,326.2 million for the nine months ended December 31, 2016, as compared to $1,193.9 million for the same period in the prior year. This increase reflects year over year growth of 5.2%, 6.1% and 16.4% in capital equipment, consumable and service revenues, respectively. The increases are attributable to acquisitions, including the Combination with Synergy, as well as organic growth, partially offset by divestitures.

Revenue from other foreign locations increased $148.1 million, or 52.7%, to $429.3 million for the nine months ended December 31, 2016, as compared to $281.2 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 nine months ended December 31, 2016 to the three months and nine months ended December 31, 2015:

                                    Three Months Ended December 31,                   Percent
(dollars in thousands)                 2016                 2015           Change      Change
Gross profit:
Product                         $       149,381       $       139,581     $  9,800       7.0 %
Service                                 108,228                98,600        9,628       9.8 %
Total gross profit              $       257,609       $       238,181     $ 19,428       8.2 %
Gross profit percentage:
Product                                    49.4 %                45.7 %
Service                                    31.4 %                31.4 %
Total gross profit percentage              39.8 %                38.5 %


                                    Nine Months Ended
                                      December 31,                       Percent
(dollars in thousands)             2016          2015         Change      Change
Gross profit:
Product                         $ 415,536     $ 368,089     $  47,447      12.9 %
Service                           329,969       263,503        66,466      25.2 %
Total gross profit              $ 745,505     $ 631,592     $ 113,913      18.0 %
Gross profit percentage:
Product                              48.0 %        45.4 %
Service                              31.0 %        35.8 %
Total gross profit percentage        38.6 %        40.8 %

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 $19.4 million, and 130 basis points as a percentage of revenues, in the fiscal 2017 third quarter as compared to the fiscal 2016 third quarter. The increase in our gross profit percentage was primarily due to the favorable impact of divestitures of lower margin operations (140 basis points) and foreign currency (60 basis points), partially offset by the addition of Synergy's hospital sterilization services and linen management business (110 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


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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 nine months of fiscal 2017 was 38.6% compared to the gross profit percentage in the first nine months of fiscal 2016 of 40.8%. The gross profit percentage decreased 220 basis points in the first nine months of fiscal 2017 over fiscal 2016. Our gross profit percentage was . . .

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