0001624899-18-000009.txt : 20181106 0001624899-18-000009.hdr.sgml : 20181106 20181106061639 ACCESSION NUMBER: 0001624899-18-000009 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 79 CONFORMED PERIOD OF REPORT: 20180930 FILED AS OF DATE: 20181106 DATE AS OF CHANGE: 20181106 FILER: COMPANY DATA: COMPANY CONFORMED NAME: STERIS plc CENTRAL INDEX KEY: 0001624899 STANDARD INDUSTRIAL CLASSIFICATION: ORTHOPEDIC, PROSTHETIC & SURGICAL APPLIANCES & SUPPLIES [3842] IRS NUMBER: 981203539 STATE OF INCORPORATION: X0 FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-37614 FILM NUMBER: 181161418 BUSINESS ADDRESS: STREET 1: RUTHERFORD HOUSE STREET 2: STEPHENSONS WAY CITY: DERBY STATE: X0 ZIP: DE21 6LY BUSINESS PHONE: (440) 354-2600 MAIL ADDRESS: STREET 1: RUTHERFORD HOUSE STREET 2: STEPHENSONS WAY CITY: DERBY STATE: X0 ZIP: DE21 6LY FORMER COMPANY: FORMER CONFORMED NAME: Steris plc DATE OF NAME CHANGE: 20151102 FORMER COMPANY: FORMER CONFORMED NAME: New STERIS Ltd DATE OF NAME CHANGE: 20141125 FORMER COMPANY: FORMER CONFORMED NAME: Solar New HoldCo Ltd DATE OF NAME CHANGE: 20141112 10-Q 1 ste0930201810-q.htm 10-Q Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
 
FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______ to _______            

Commission File Number 1-37614
STERIS plc
(Exact name of registrant as specified in its charter)

England and Wales
 
98-1203539
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification No.)
 
 
Rutherford House Stephensons Way Chaddesden, Derby, England

 
DE21 6LY
(Address of principal executive offices)
 
(Zip code)
44 1332 387100
(Registrant’s telephone number, including area code)
____________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  x    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer  x
  
Accelerated Filer  o
Non-Accelerated Filer  o

  
Smaller Reporting Company  o
 
 
Emerging Growth Company  o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
The number of ordinary shares outstanding as of November 2, 2018: 84,499,655

1


STERIS plc and Subsidiaries
Form 10-Q
Index
 


2


PART 1—FINANCIAL INFORMATION
As used in this Quarterly Report on Form 10-Q, STERIS plc and its subsidiaries together are called “STERIS,” the “Company,” “we,” “us,” or “our,” unless otherwise noted.

ITEM 1.
FINANCIAL STATEMENTS

STERIS PLC AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
 
 
September 30,
2018
 
March 31,
2018
 
 
(Unaudited)
 
 
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
209,921

 
$
201,534

Accounts receivable (net of allowances of $9,781 and $12,472, respectively)
 
490,952

 
528,066

Inventories, net
 
230,828

 
205,731

Prepaid expenses and other current assets
 
47,819

 
54,326

Total current assets
 
979,520

 
989,657

Property, plant, and equipment, net
 
986,213

 
1,010,524

Goodwill and intangibles, net
 
3,008,866

 
3,160,764

Other assets
 
46,691

 
39,389

Total assets
 
$
5,021,290

 
$
5,200,334

Liabilities and equity
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
125,549

 
$
135,866

Accrued income taxes
 

 
379

Accrued payroll and other related liabilities
 
73,581

 
94,000

Accrued expenses and other
 
173,462

 
168,217

Total current liabilities
 
372,592

 
398,462

Long-term indebtedness
 
1,267,723

 
1,316,001

Deferred income taxes, net
 
154,098

 
159,971

Other liabilities
 
101,900

 
108,600

Total liabilities
 
$
1,896,313

 
$
1,983,034

Commitments and contingencies (see Note 8)
 

 

Preferred shares, with £0.10 par value; 100 shares authorized; 100 issued and outstanding
 
15

 
15

Ordinary shares, with £0.10 par value; £17,006 shares aggregate par amount authorized; 84,495 and 84,747 ordinary shares issued and outstanding, respectively
 
2,012,566

 
2,048,037

Retained earnings
 
1,232,062

 
1,146,223

Accumulated other comprehensive income (loss)
 
(126,780
)
 
11,685

Total shareholders’ equity
 
3,117,863

 
3,205,960

Noncontrolling interests
 
7,114

 
11,340

Total equity
 
3,124,977

 
3,217,300

Total liabilities and equity
 
$
5,021,290

 
$
5,200,334


See notes to consolidated financial statements.

3


STERIS PLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
(Unaudited)
 
 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 
 
 
 
 
 
 
Product
 
$
314,659

 
$
286,557

 
$
593,449

 
$
560,162

Service
 
364,302

 
347,602

 
724,270

 
681,961

Total revenues
 
678,961

 
634,159

 
1,317,719

 
1,242,123

Cost of revenues:
 
 
 
 
 
 
 
 
Product
 
172,107

 
152,611

 
318,709

 
295,856

Service
 
222,190

 
215,151

 
445,296

 
424,103

Total cost of revenues
 
394,297

 
367,762

 
764,005

 
719,959

Gross profit
 
284,664

 
266,397

 
553,714

 
522,164

Operating expenses:
 
 
 
 
 
 
 
 
Selling, general, and administrative
 
162,312

 
153,879

 
320,718

 
310,216

Research and development
 
15,773

 
13,974

 
31,993

 
27,978

Restructuring expenses
 

 
27

 

 
78

Total operating expenses
 
178,085

 
167,880

 
352,711

 
338,272

Income from operations
 
106,579

 
98,517

 
201,003

 
183,892

Non-operating expenses, net:
 
 
 
 
 
 
 
 
Interest expense
 
11,393

 
12,683

 
23,134

 
25,149

Interest (income) and miscellaneous expense, net
 
(73
)
 
(1,513
)
 
(441
)
 
(2,858
)
Total non-operating expenses, net
 
11,320

 
11,170

 
22,693

 
22,291

Income before income tax expense
 
95,259

 
87,347

 
178,310

 
161,601

Income tax expense
 
17,764

 
22,903

 
30,537

 
38,942

Net income
 
77,495

 
64,444

 
147,773

 
122,659

Less: Net income (loss) attributable to noncontrolling interests
 
38

 
(15
)
 
325

 
123

Net income attributable to shareholders
 
$
77,457

 
$
64,459

 
$
147,448

 
$
122,536

 
 
 
 
 
 
 
 
 
Net income per share attributed to shareholders
 
 
 
 
 
 
 
 
Basic
 
$
0.92

 
$
0.76

 
$
1.74

 
$
1.44

Diluted
 
$
0.91

 
$
0.75

 
$
1.72

 
$
1.43

Cash dividends declared per share ordinary outstanding
 
$
0.34

 
$
0.31

 
$
0.65

 
$
0.59


See notes to consolidated financial statements.


4


STERIS PLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
(Unaudited)

 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Net income
 
$
77,495

 
$
64,444

 
$
147,773

 
$
122,659

  Less: Net income (loss) attributable to noncontrolling
  interests
 
38

 
(15
)
 
325

 
123

Net income attributable to shareholders
 
77,457

 
64,459

 
147,448

 
122,536

 
 
 
 
 
 
 
 
 
Other comprehensive income (loss)
 
 
 
 
 
 
 
 
Unrealized gain (loss) on available for sale securities, (net of taxes of $0, $268, $0 and $483, respectively)
 

 
1,103

 

 
1,771

Amortization of pension and postretirement benefit plans costs, (net of taxes of $169, $250, $338 and $500, respectively)
 
(413
)
 
(404
)
 
(823
)
 
(808
)
Change in cumulative currency translation adjustment
 
(5,271
)
 
66,819

 
(135,672
)
 
159,680

Total other comprehensive income (loss)
 
(5,684
)
 
67,518

 
(136,495
)
 
160,643

Comprehensive income
 
$
71,773

 
$
131,977

 
$
10,953

 
$
283,179


See notes to consolidated financial statements.




5


STERIS PLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
 
 
 
Six Months Ended September 30,
 
 
2018
 
2017
Operating activities:
 
 
 
 
Net income
 
$
147,773

 
$
122,659

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation, depletion, and amortization
 
92,971

 
89,199

Deferred income taxes
 
2,242

 
(3,272
)
Share-based compensation expense
 
12,938

 
12,029

(Gain) on the disposal of property, plant, equipment, and intangibles, net
 
(385
)
 
(578
)
Loss on sale of businesses, net
 
663

 
1,134

Other items
 
(16,329
)
 
7,521

Changes in operating assets and liabilities, net of effects of acquisitions:
 
 
 
 
Accounts receivable, net
 
29,024

 
42,769

Inventories, net
 
(32,955
)
 
(19,009
)
Other current assets
 
4,689

 
(4,225
)
Accounts payable
 
(7,385
)
 
(8,615
)
Accruals and other, net
 
(6,544
)
 
(22,235
)
Net cash provided by operating activities
 
226,702

 
217,377

Investing activities:
 
 
 
 
Purchases of property, plant, equipment, and intangibles, net
 
(62,549
)
 
(75,420
)
Proceeds from the sale of property, plant, equipment, and intangibles
 
5,547

 
2,075

Proceeds from the sale of businesses
 
(196
)
 
1,313

Purchase of investments
 
(4,955
)
 

Acquisition of businesses, net of cash acquired
 

 
(29,509
)
Other
 
(6,003
)
 

Net cash used in investing activities
 
(68,156
)
 
(101,541
)
Financing activities:
 
 
 
 
Payments on long-term obligations
 
(85,000
)
 
(15,000
)
Proceeds (payments) under credit facilities, net
 
52,093

 
(38,199
)
Deferred financing fees and debt issuance costs
 
(298
)
 
(44
)
Acquisition related deferred or contingent consideration
 
(685
)
 
(1,876
)
Repurchases of ordinary shares
 
(55,902
)
 
(20,652
)
Cash dividends paid to ordinary shareholders
 
(55,005
)
 
(50,280
)
Stock option and other equity transactions, net
 
4,936

 
6,706

Net cash used in financing activities
 
(139,861
)
 
(119,345
)
Effect of exchange rate changes on cash and cash equivalents
 
(10,298
)
 
16,219

Increase in cash and cash equivalents
 
8,387

 
12,710

Cash and cash equivalents at beginning of period
 
201,534

 
282,918

Cash and cash equivalents at end of period
 
$
209,921

 
$
295,628

See notes to consolidated financial statements.

6


STERIS PLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
For the Three and Six Months Ended September 30, 2018 and 2017
(dollars in thousands, unless noted and except per share amounts)

1. Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations
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 Company is a leading provider of infection prevention and other procedural products and services. We offer our Customers a unique mix of innovative consumable products, such as detergents, gastrointestinal ("GI") endoscopy accessories, barrier product solutions, and other products and services, including: equipment installation and maintenance, microbial reduction of medical devices, instrument and scope repair solutions, laboratory testing services, on-site and off-site reprocessing, and capital equipment products, such as sterilizers and surgical tables, and connectivity solutions such as operating room (“OR”) integration.
Our fiscal year ends on March 31. References in this Quarterly Report to a particular “year” or “year-end” mean our fiscal year. The significant accounting policies applied in preparing the accompanying consolidated financial statements of the Company are summarized below:
Interim Financial Statements
We prepared the accompanying unaudited consolidated financial statements of the Company according to accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and the instructions to the Quarterly Report on Form 10-Q and Rule 10-01 of Regulation S-X. This means that they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. Our unaudited interim consolidated financial statements contain all material adjustments (including normal recurring accruals and adjustments) management believes are necessary to fairly state our financial condition, results of operations, and cash flows for the periods presented.
These interim consolidated financial statements should be read together with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended March 31, 2018 dated May 30, 2018. The Consolidated Balance Sheet at March 31, 2018 was derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements.
Principles of Consolidation
We use the consolidation method to report our investment in our subsidiaries. Therefore, the accompanying consolidated financial statements include the accounts of the Company and its wholly-owned and majority-owned subsidiaries. We eliminate inter-company accounts and transactions when we consolidate these accounts. Investments in equity of unconsolidated affiliates, over which the Company has significant influence, but not control, over the financial and operating polices, are accounted for primarily using the equity method. These investments are immaterial to the Company's Consolidated Financial Statements.
Use of Estimates
We make certain estimates and assumptions when preparing financial statements according to U.S. GAAP that affect the reported amounts of assets and liabilities at the financial statement dates and the reported amounts of revenues and expenses during the periods presented. These estimates and assumptions involve judgments with respect to many factors that are difficult to predict and are beyond our control. Actual results could be materially different from these estimates. We revise the estimates and assumptions as new information becomes available. This means that operating results for the three and six month periods ended September 30, 2018 are not necessarily indicative of results that may be expected for future quarters or for the full fiscal year ending March 31, 2019.
Revenue Recognition and Associated Liabilities
We adopted Accounting Standards Update ("ASU") 2014-09 “Revenue from Contracts with Customers” and the subsequently issued amendments on April 1, 2018 using the modified retrospective approach to contracts that were not

7

STERIS PLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)—(Continued)
For the Three and Six Months Ended September 30, 2018 and 2017
(dollars in thousands, except as noted)



completed as of April 1, 2018. Under this standard, certain capital equipment contracts are comprised of a single performance obligation, resulting in the deferral of the corresponding capital equipment revenue and cost of revenues until installation is complete. Previously, these capital equipment revenues and cost of revenues were recognized based upon shipping terms. We recorded a cumulative effect adjustment in the beginning of fiscal 2019 to Retained earnings of $5,637, based on the current terms and conditions for certain open capital equipment contracts as of March 31, 2018. The impact of the adoption of this standard on our Consolidated Balance Sheets at September 30, 2018 is reflected in the table below. The adoption of this standard did not have a material impact on our Consolidated Statements of Income for the quarter-to-date and year-to-date periods ending September 30, 2018. Comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods.
 
As Reported September 30,
Total
ASC 605 September 30,
Balance Sheet
2018
Adjustments
2018
 
 
 
 
Total assets
$
5,021,290

$
(6,849
)
$
5,014,441

Total liabilities
1,896,313

(12,958
)
1,883,355

Total equity
3,124,977

6,109

3,131,086

Revenue is recognized when obligations under the terms of the contract are satisfied and control of the promised products or services have transferred to the Customer. Revenues are measured at the amount of consideration that we expect to be paid in exchange for the products or services. Product revenue is recognized when control passes to the Customer, which is generally based on contract or shipping terms. Service revenue is recognized when the Customer benefits from the service, which occurs either upon completion of the service or as it is provided to the Customer. Our Customers include end users as well as dealers and distributors who market and sell our products. Our revenue is not contingent upon resale by the dealer or distributor, and we have no further obligations related to bringing about resale. Our standard return and restocking fee policies are applied to sales of products. Shipping and handling costs charged to Customers are included in Product revenues. The associated expenses are treated as fulfillment costs and are included in Cost of revenues. Revenues are reported net of sales and value-added taxes collected from Customers.
We have individual Customer contracts that offer discounted pricing. Dealers and distributors may be offered sales incentives in the form of rebates. We reduce revenue for discounts and estimated returns, rebates, and other similar allowances in the same period the related revenues are recorded. The reduction in revenue for these items is estimated based on historical experience and trend analysis to the extent that it is probable that a significant reversal of revenue will not occur. Estimated returns are recorded gross on the Consolidated Balance Sheets.
In transactions that contain multiple performance obligations, such as when products, maintenance services, and other services are combined, we recognize revenue as each product is delivered or service is provided to the Customer. We allocate the total arrangement consideration to each performance obligation based on its relative standalone selling price, which is the price for the product or service when it is sold separately.
Payment terms vary by the type and location of the Customer and the products or services offered. Generally, the time between when revenue is recognized and when payment is due is not significant. We do not evaluate whether the selling price contains a financing component for contracts that have a duration of less than one year.
We do not capitalize sales commissions as substantially all of our sales commission programs have an amortization period of one year or less.
Certain costs to fulfill a contract are capitalized and amortized over the term of the contract if they are recoverable, directly related to a contract and generate resources that we will use to fulfill the contract in the future. At September 30, 2018, assets related to costs to fulfill a contract were not material to our Consolidated Financial Statements.
Refer to Note 9, titled "Business Segment Information" for disaggregation of revenue.

8

STERIS PLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)—(Continued)
For the Three and Six Months Ended September 30, 2018 and 2017
(dollars in thousands, except as noted)



Product Revenue
Product revenues consist of revenues generated from sales of consumables and capital equipment. These contracts are primarily based on a Customer’s purchase order and may include a Distributor, Dealer or Group Purchasing Organization ("GPO") agreement. We recognize revenue for sales of product when control passes to the Customer, which generally occurs either when the products are shipped or when they are received by the Customer. Revenue related to certain capital equipment products is deferred until installation is complete as the capital equipment and installation are highly integrated and form a single performance obligation.
Service Revenue
Within our Healthcare Products and Life Sciences segments, service revenues consist of revenue generated from parts and labor associated with the maintenance, repair and installation of capital equipment. These contracts are primarily based on a Customer’s purchase order and may include a Distributor, Dealer, or GPO agreement. For maintenance, repair and installation of capital equipment, revenue is recognized upon completion of the service.
We also offer preventive maintenance and separately priced extended warranty agreements to our Customers, which require us to maintain and repair our products over the duration of the contract. Generally, these contract terms are cancelable without penalty and range from one to five years. Amounts received under these Customer contracts are initially recorded as a service liability and are recognized as service revenue ratably over the contract term using a time-based input measure.
Within our Healthcare Specialty Services segment, revenues relate primarily to outsourced reprocessing services and instrument repairs. Contracts for outsourced reprocessing services are primarily based on an agreement with a Customer, ranging in length from several months to 15 years. Outsourced reprocessing services revenue is recognized ratably over the contract term using a time-based input measure, adjusted for volume and other performance metrics, to the extent that it is probable that a significant reversal of revenue will not occur. Contracts for instrument repairs are primarily based on a Customer’s purchase order, and the associated revenue is recognized upon completion of the repair.
Within our Applied Sterilization Technologies segment, service revenues include contract sterilization and laboratory services. Sales contracts for contract sterilization and laboratory services are primarily based on a Customer’s purchase order and associated Customer agreement and revenues are generally recognized upon completion of the service.
Contract Liabilities
Payments received from Customers are based on invoices or billing schedules as established in contracts with Customers. Deferred revenue is recorded when payment is received in advance of performance under the contract. Deferred revenue is recognized as revenue upon completion of the performance obligation, which generally occurs within one year. During the first half of fiscal 2019, we recognized revenue of $20,235 that was included in our contract liability balance at the beginning of the period.
Refer to Note 6, titled "Additional Consolidated Balance Sheet Information" for Deferred revenue balances.
Service Liabilities
Payments received in advance of performance for cancelable preventative maintenance and separately priced extended warranty contracts are recorded as service liabilities. Service liabilities are recognized as revenue as performance is rendered under the contract. Prior to the adoption of Accounting Standards Codification ("ASC") 606, these amounts were included in Deferred revenues.
Refer to Note 6, titled "Additional Consolidated Balance Sheet Information" for Service liability balances.
Remaining Performance Obligations
Remaining performance obligations reflect only the performance obligations related to agreements for which we have a firm commitment from a Customer to purchase and exclude variable consideration related to unsatisfied performance obligations. With regard to products, these remaining performance obligations include capital equipment and consumable orders which have not shipped. With regard to service, these remaining performance obligations primarily include installation, certification, and outsourced reprocessing services. As of September 30, 2018, the transaction price allocated to remaining performance obligations was approximately $790,000. We expect to recognize approximately 51% of the transaction price within one year and approximately 41% beyond one year. The remainder has yet to be scheduled for delivery.

9

STERIS PLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)—(Continued)
For the Three and Six Months Ended September 30, 2018 and 2017
(dollars in thousands, except as noted)



Recently Issued Accounting Standards Impacting the Company

Recently Issued Accounting Standards impacting or that may impact the Company are presented in the following table:
Standard
 
Date of Issuance
 
Description
 
Date of Adoption
 
Effect on the financial statements or other significant matters
Standards that have recently been adopted
ASU 2014-09, "Revenue from Contracts with Customers" and subsequently issued amendments
 
May 2014
 
The standard replaced existing revenue recognition standards and significantly expands the disclosure requirements for revenue arrangements.
 
First Quarter Fiscal 2019
 
Additional information is disclosed in Footnote 1 under the heading, "Revenue Recognition and Associated Liabilities".
ASU 2016-01, "Financial Instruments - Overall - Recognition and Measurement of Financial Assets and Liabilities"
(Subtopic
825-10)
 
January 2016
 
The standard changed how equity investments are measured and presented changes in the fair value of financial liabilities measured under the fair value option. Presentation and disclosure requirements for financial instruments were also affected. Entities are required to measure equity investments that do not result in consolidation and are not recorded under the equity method at fair value with changes in fair value recognized in net income. The standard clarifies guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale securities. The accounting for other financial instruments, such as loans, investments in debt securities, and financial liabilities is largely unchanged.
 
First Quarter Fiscal 2019
 
We adopted the standard on a modified retrospective basis at the beginning of fiscal 2019 and we recorded a cumulative effect adjustment to our opening retained earnings balance of $1,970 that increased retained earnings and decreased accumulated other comprehensive income.

ASU 2016-15, "Statement of Cash Flows"
(Topic 230)
 
August 2016
 
This standard provides guidance on the following specific cash flow issues: Debt prepayment or debt extinguishment costs, settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of borrowing, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies, distributions received from equity method investees, beneficial interests in securitization transactions, and separately identifiable cash flows and application of the predominance principle.
 
First Quarter Fiscal 2019
 
We adopted this standard effective April 1, 2018. The impact will depend on the future occurrence of the relevant transactions or conditions addressed by the standard.

10

STERIS PLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)—(Continued)
For the Three and Six Months Ended September 30, 2018 and 2017
(dollars in thousands, except as noted)



ASU 2016-16, "Income Taxes, Intra-Entity Transfers of Assets Other Than Inventory"
(Topic 740)
 
October 2016
 
The standard improves the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. The new standard requires the recognition of income tax consequences resulting from an intra-entity transfer of an asset other than inventory when the transfer occurs.
 
First Quarter Fiscal 2019
 
We adopted this standard effective April 1, 2018 with no material impact to our Consolidated Balance Sheets. The impact to our Consolidated Statements of Income will depend on the value of future intra-entity transfers.
ASU 2017-01 "Clarifying the Definition of a Business"
 
January 2017
 
The standard update narrows the definition of a business by providing a screen to determine when an integrated set of assets and activities is not a business.  The screen specifies that an integrated set of assets and activities is not a business if substantially all of the fair value of the gross assets acquired or disposed of is concentrated in a single or a group of similar identifiable assets. 
 
First Quarter Fiscal 2019
 
We adopted this standard effective April 1, 2018. The impact will depend on the future occurrence of the relevant transactions or conditions addressed by the standard.
ASU 2017-07
"Compensation - Retirement Benefits - Improving the Presentation of Net Periodic Pension and Net Periodic Postretirement Benefit Cost"
(Topic 715)
 
March 2017
 
This standard requires that an employer report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside the subtotal of income from operations, if one is presented.
 
First Quarter Fiscal 2019
 
We retrospectively adopted the standard in the first quarter of fiscal 2019. Prior periods have been recast for the adoption of this standard. Changes have been reflected in the Cost of Revenues, Selling, general and administrative expense, and Interest income and miscellaneous expense lines of our Consolidated Statements of Income. Amounts are not considered material for additional disclosure.

                                                                                                                                        
ASU 2017-09 "Compensation - Stock Compensation" (Topic 718)
 
May 2017
 
The standard provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718.

 
First Quarter Fiscal 2019
 
We adopted this standard effective April 1, 2018. The impact will depend on the future occurrence of the relevant terms or conditions addressed by the standard.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

11

STERIS PLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)—(Continued)
For the Three and Six Months Ended September 30, 2018 and 2017
(dollars in thousands, except as noted)



 
 
 
 
 
 
 
 
 
Standards that have not yet been adopted
ASU 2016-02, "Leases"
(Topic 842)
 
February 2016
 
The standard will require lessees to record all leases, whether finance or operating, on the balance sheet. An asset will be recorded to represent the right to use the leased asset, and a liability will be recorded to represent the lease obligation. The standard is effective for annual periods beginning after December 15, 2018 and interim periods within that period. Early adoption is permitted.
 
N/A
 
We are currently evaluating the impact that the standard will have on our consolidated financial statements. We are also evaluating our lease portfolio, software packages, process and policy change requirements. We expect to adopt this standard using the additional, optional transition method, the package of transitional practical expedients relating to the identification, classification and initial direct costs of leases, and the transitional practical expedient for the treatment of existing land easements; however, we do not expect to elect the hindsight transitional practical expedient. We anticipate that most of our operating leases will result in the recognition of additional assets and corresponding liabilities in our Consolidated Balance Sheet, however we do not expect the standard to have a material impact on our financial position. The actual impact will depend on our lease portfolio at the time of adoption. For more information regarding our total operating lease commitments refer to Note 5, "Property, Plant and Equipment" of our Annual Report on Form 10-K for the year ended March 31, 2018 dated May 30, 2018.

ASU 2016-13, "Measurement of Credit Losses on Financial Instruments"
 
June 2016
 
The standard requires a financial asset (or group of financial assets) measured at amortized cost to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses. The standard is effective for annual periods beginning after December 15, 2019. Early adoption is permitted.
 
N/A
 
We are in the process of evaluating the impact that the standard will have on our consolidated financial statements.

12

STERIS PLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)—(Continued)
For the Three and Six Months Ended September 30, 2018 and 2017
(dollars in thousands, except as noted)



ASU 2017-12 "Targeted Improvements to Accounting for Hedging Activities" (Topic 815)
 
August 2017
 
The standard provides targeted improvements to accounting for hedging activities by expanding an entity’s ability to hedge non-financial and financial risk components and reduce complexity in fair value hedges of interest rate risk. The guidance eliminates the requirement to separately measure and report hedge ineffectiveness and generally requires the entire change in the fair value of a hedging instrument to be presented in the same income statement line as the hedged item. The guidance also eases certain documentation and assessment requirements and modifies the accounting for components excluded from the assessment of hedge effectiveness. The standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. Early adoption is permitted in any interim period after issuance of the standard. The standard should be applied using a modified retrospective approach for cash flow and net investment hedge relationships that exist on the date of adoption, and prospectively for presentation and disclosure requirements.

 
N/A
 
We do not expect this standard to have a material impact on our consolidated financial statements.
ASU 2018-02
"Income Statement - Reporting Comprehensive Income" (Topic 220)
 
February 2018
 
The standard allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act ("TCJA") and requires certain disclosures about stranded tax effects. The underlying guidance requiring that the effect of a change in tax laws or rates be included in income from continuing operations is not affected. This standard is effective for fiscal years beginning after December 15, 2018 and interim periods within those years. Early adoption is permitted.
 
N/A
 
We are in the process of evaluating the impact that the standard will have on our consolidated financial statements.
ASU 2018-13 "Fair Value Measurement (Topic 820) Disclosure Framework- Changes to Disclosure Requirements for Fair Value Measurement”

 
August 2018
 
The standard modifies the disclosure requirements by adding, removing, and modifying certain required disclosures for fair value measurements for assets and liabilities disclosed within the fair value hierarchy.  The standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019 and early adoption is permitted.

 
N/A
 
We do not expect this standard to have a material impact on our consolidated financial statements as it modifies disclosure requirements only.
ASU 2018-14 "Compensation- Retirement Benefits - Defined Benefit Plans- General Topic (715-20): Disclosure Framework- Changes to the Disclosure Requirements for Defined Benefit Plans"
 
August 2018
 
The standard modifies the disclosure requirements by adding, removing, and modifying certain required disclosures for employers that sponsor defined benefit pension or other post-retirement benefit plans.  The standard also clarifies disclosure requirements for defined benefit pension plans relating to the projected benefit obligation and accumulated benefit obligation.  The standard is effective for fiscal years ending after December 15, 2019 and early adoption is permitted.

 
N/A
 
We do not expect this standard to have a material impact on our consolidated financial statements as it modifies disclosure requirements only.

13

STERIS PLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)—(Continued)
For the Three and Six Months Ended September 30, 2018 and 2017
(dollars in thousands, except as noted)



ASU 2018-15 "Intangibles- Goodwill and Other- Internal Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract"
 
August 2018
 
The standard aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or
obtain internal-use software. The standard is effective for fiscal years ending after December 15, 2019 and early adoption is permitted.

 
N/A
 
We do not expect this standard to have a material impact on our consolidated financial statements.
A detailed description of our significant and critical accounting policies, estimates, and assumptions is included in our consolidated financial statements included in our Annual Report on Form 10-K for the year ended March 31, 2018 dated May 30, 2018. With the exception of the adoption of ASU 2014-09, as discussed in Footnote 1 under the heading, "Revenue Recognition and Associated Liabilities", our significant and critical accounting policies, estimates, and assumptions have not changed materially from March 31, 2018.

14

STERIS PLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)—(Continued)
For the Three and Six Months Ended September 30, 2018 and 2017
(dollars in thousands, except as noted)



2. Business Acquisitions and Divestitures
Fiscal 2018
During fiscal 2018, we completed several minor purchases which continued to expand our product offerings in the Healthcare Products, Healthcare Specialty Services and Applied Sterilization Technologies segments. The aggregate purchase price associated with these transactions was approximately $52,900 ($34,200 during the first half of fiscal 2018), net of cash acquired and including potential contingent consideration of $5,400. The purchase price for the acquisitions was financed with both cash on hand and with credit facility borrowings. Purchase price allocations are finalized within a measurement period not to exceed one year from closing. Any provisional adjustments recorded were not material.
On November 20, 2017, we sold our Synergy Health Healthcare Consumable Solutions ("HCS") business to Vernacare. Annual revenues for the HCS business were approximately $40,000 and were included in the Healthcare Products segment. We recorded proceeds of approximately $8,200, net of cash divested and including a working capital adjustment. We also recognized a pre-tax loss on the sale of approximately $13,500 in Selling, general, and administrative expense in our March 31, 2018 Consolidated Statement of Income.

3. Inventories, Net
We use the last-in, first-out (“LIFO”) and first-in, first-out (“FIFO”) cost methods to value inventory. Inventory valued using the LIFO cost method is stated at the lower of cost or market. Inventory valued using the FIFO cost method is stated at the lower of cost or net realizable value. An actual valuation of inventory under the LIFO method is made only at the end of the fiscal year based on the inventory levels and costs at that time. Accordingly, interim LIFO calculations are based on management’s estimates of expected year-end inventory levels and are subject to the final fiscal year-end LIFO inventory valuation. Inventory costs include material, labor, and overhead. Inventories, net consisted of the following:
 
 
September 30,
2018
 
March 31,
2018
Raw materials
 
$
87,296

 
$
83,741

Work in process
 
30,995

 
34,904

Finished goods
 
149,111

 
124,005

LIFO reserve
 
(17,800
)
 
(17,280
)
Reserve for excess and obsolete inventory
 
(18,774
)
 
(19,639
)
Inventories, net
 
$
230,828

 
$
205,731


4. Property, Plant and Equipment
Information related to the major categories of our depreciable assets is as follows:
 
 
September 30,
2018
 
March 31,
2018
Land and land improvements (1)
 
$
61,297

 
$
55,417

Buildings and leasehold improvements
 
433,387

 
449,316

Machinery and equipment
 
585,136

 
575,607

Information systems
 
156,117

 
145,726

Radioisotope
 
481,591

 
476,578

Construction in progress (1)
 
105,214

 
87,745

Total property, plant, and equipment
 
1,822,742

 
1,790,389

Less: accumulated depreciation and depletion
 
(836,529
)
 
(779,865
)
Property, plant, and equipment, net
 
$
986,213

 
$
1,010,524

(1) 
Land is not depreciated. Construction in progress is not depreciated until placed in service.

15

STERIS PLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)—(Continued)
For the Three and Six Months Ended September 30, 2018 and 2017
(dollars in thousands, except as noted)




5. Debt
Indebtedness was as follows:
 
 
September 30,
2018
 
March 31,
2018
Credit Agreement and Swing Line Facility
 
$
381,917

 
$
331,206

Private Placement Notes
 
888,858

 
988,190

Deferred financing costs
 
(3,119
)
 
(3,395
)
Other
 
67

 

Total long term debt
 
$
1,267,723

 
$
1,316,001

Additional information regarding our indebtedness is included in the notes to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended March 31, 2018 dated May 30, 2018.
6. Additional Consolidated Balance Sheet Information
Additional information related to our Consolidated Balance Sheets is as follows:
 
 
September 30,
2018
 
March 31,
2018
Accrued payroll and other related liabilities:
 
 
 
 
Compensation and related items
 
$
29,735

 
$
30,270

Accrued vacation/paid time off
 
11,070

 
11,011

Accrued bonuses
 
17,403

 
31,716

Accrued employee commissions
 
12,003

 
17,168

Other postretirement benefit obligations-current portion
 
1,906

 
1,906

Other employee benefit plans obligations-current portion
 
1,464

 
1,929

Total accrued payroll and other related liabilities
 
$
73,581

 
$
94,000

Accrued expenses and other:
 
 
 
 
Deferred revenues
 
$
46,854

 
$
31,621

Service liabilities
 
44,376

 
43,077

Self-insured risk reserves-current portion
 
7,645

 
7,349

Accrued dealer commissions
 
13,792

 
16,121

Accrued warranty
 
7,026

 
6,872

Asset retirement obligation-current portion
 
1,775

 
1,798

Other
 
51,994

 
61,379

Total accrued expenses and other
 
$
173,462

 
$
168,217

Other liabilities:
 
 
 
 
Self-insured risk reserves-long-term portion
 
$
15,008

 
$
15,008

Other postretirement benefit obligations-long-term portion
 
10,934

 
12,194

Defined benefit pension plans obligations-long-term portion
 
25,697

 
29,407

Other employee benefit plans obligations-long-term portion
 
2,834

 
3,221

Accrued long-term income taxes
 
18,966

 
18,922

Asset retirement obligation-long-term portion
 
9,589

 
9,841

Other
 
18,872

 
20,007

Total other liabilities
 
$
101,900

 
$
108,600



16

STERIS PLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)—(Continued)
For the Three and Six Months Ended September 30, 2018 and 2017
(dollars in thousands, except as noted)



7. Income Tax Expense
The Tax Cuts and Jobs Act (the “TCJA”) was enacted on December 22, 2017. The TCJA reduces the U.S. federal corporate income tax rate from 35.0% to 21.0%, requires companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred and creates new taxes on certain foreign sourced earnings. The Company is applying the guidance in Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cut and Jobs Act when accounting for the enactment-date effects of the TCJA. At September 30, 2018, the Company has not completed its accounting for the tax effects of the TCJA; however, it has made reasonable estimates of the tax effects. During the six months ended September 30, 2018, the Company has not recorded any adjustments to the provisional amounts recorded at March 31, 2018 related to the remeasurement of its deferred balances and the one-time transition tax.  In all cases, the Company is continuing to make and refine its calculations as additional analysis is completed. In addition, the Company’s estimates may also be affected as it gains a more thorough understanding of the TCJA and certain aspects of the TCJA are clarified by the taxing authorities.
The TCJA also subjects a U.S. shareholder to current tax on global intangible low-taxed income (“GILTI”) earned by certain foreign subsidiaries and allows a benefit for foreign-derived intangible income (“FDII”). The Company has made sufficient progress in its calculation to reasonably estimate the tax impact related to GILTI and FDII for the year ended March 31, 2019 and included it in the estimated annual effective tax rate. The impact of GILTI and FDII was not significant for the six months ended September 30, 2018. The Company will continue to refine its calculations, which may result in changes to the expected impact for fiscal year 2019.
The effective income tax rates for the three month periods ended September 30, 2018 and 2017 were 18.6% and 26.2%, respectively. The effective income tax rates for the six month periods ended September 30, 2018 and 2017 were 17.1% and 24.1%, respectively. The fiscal 2019 rate was favorably impacted compared to the prior year periods primarily by the decrease in the U.S. federal statutory tax rate.
Income tax expense is provided on an interim basis based upon our estimate of the annual effective income tax rate, adjusted each quarter for discrete items. In determining the estimated annual effective income tax rate, we analyze various factors, including projections of our annual earnings and taxing jurisdictions in which the earnings will be generated, the impact of state and local income taxes, our ability to use tax credits and net operating loss carry forwards, and available tax planning alternatives.
We operate in numerous taxing jurisdictions and are subject to regular examinations by various United States federal, state and local, as well as non-United States jurisdictions. We are no longer subject to United States federal examinations for years before fiscal 2015 and, with limited exceptions, we are no longer subject to United States state and local, or non-United States, income tax examinations by tax authorities for years before fiscal 2011. We remain subject to tax authority audits in various jurisdictions wherever we do business. We do not expect the results of these examinations to have a material adverse effect on our consolidated financial statements.


17

STERIS PLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)—(Continued)
For the Three and Six Months Ended September 30, 2018 and 2017
(dollars in thousands, except as noted)



8. Commitments and Contingencies
We are, and will likely continue to be, involved in a number of legal proceedings, government investigations, and claims, which we believe generally arise in the course of our business, given our size, history, complexity, and the nature of our business, products, Customers, regulatory environment, and industries in which we participate. These legal proceedings, investigations and claims generally involve a variety of legal theories and allegations, including, without limitation, personal injury (e.g., slip and falls, burns, vehicle accidents), product liability or regulation (e.g., based on product operation or claimed malfunction, failure to warn, failure to meet specification, or failure to comply with regulatory requirements), product exposure (e.g., claimed exposure to chemicals, asbestos, contaminants, radiation), property damage (e.g., claimed damage due to leaking equipment, fire, vehicles, chemicals), commercial claims (e.g., breach of contract, economic loss, warranty, misrepresentation), financial (e.g., taxes, reporting), employment (e.g., wrongful termination, discrimination, benefits matters), and other claims for damage and relief.
We believe we have adequately reserved for our current litigation and claims that are probable and estimable, and further believe that the ultimate outcome of these pending lawsuits and claims will not have a material adverse effect on our consolidated financial position or results of operations taken as a whole. Due to their inherent uncertainty, however, there can be no assurance of the ultimate outcome or effect of current or future litigation, investigations, claims or other proceedings (including without limitation the matters discussed below). For certain types of claims, we presently maintain insurance coverage for personal injury and property damage and other liability coverages in amounts and with deductibles that we believe are prudent, but there can be no assurance that these coverages will be applicable or adequate to cover adverse outcomes of claims or legal proceedings against us.
On May 31, 2012, our Albert Browne Limited subsidiary received a warning letter from the FDA regarding chemical indicators manufactured in the United Kingdom. These devices are intended for the monitoring of certain sterilization and other processes. The FDA warning letter states that the agency has concerns regarding operational business processes. We do not believe that the FDA's concerns are related to product performance, or that they result from Customer complaints. We have reviewed our processes with the agency and finalized our remediation measures, and are awaiting FDA reinspection. We do not currently believe that the impact of this event will have a material adverse effect on our financial results.
Civil, criminal, regulatory or other proceedings involving our products or services could possibly result in judgments, settlements or administrative or judicial decrees requiring us, among other actions, to pay damages or fines or effect recalls, or be subject to other governmental, Customer or other third party claims or remedies, which could materially effect our business, performance, prospects, value, financial condition, and results of operations.
For additional information regarding these matters, see the following portions of our Annual Report on Form 10-K for the year ended March 31, 2018 dated May 30, 2018: Item 1 titled “Business - Information with respect to our Business in General - Government Regulation”, and the “Risk Factors” in Item 1A titled "Product related regulations and claims".
From time to time, STERIS is also involved in legal proceedings as a plaintiff involving contract, patent protection, and other claims asserted by us. Gains, if any, from these proceedings are recognized when they are realized.
We are subject to taxation from United States federal, state and local, and non-U.S. jurisdictions. Tax positions are settled primarily through the completion of audits within each individual jurisdiction or the closing of statutes of limitation. Changes in applicable tax law or other events may also require us to revise past estimates. We describe income taxes further in Note 7 to our consolidated financial statements titled, “Income Tax Expense” in this Quarterly Report on Form 10-Q.
9. Business Segment Information
We operate and report our financial information in four reportable business segments: Healthcare Products, Healthcar Specialty Services, Life Sciences, and Applied Sterilization Technologies. Corporate, which is presented separately, contains costs that are associated with being a publicly traded company and certain other corporate costs.
Our Healthcare Products segment offers infection prevention and procedural solutions for healthcare providers worldwide, including consumable products, equipment maintenance and installation services, and capital equipment.
Our Healthcare Specialty Services segment provides a range of specialty services for healthcare providers including hospital sterilization services, and instrument and scope repairs.
Our Life Sciences segment offers consumable products, equipment maintenance and specialty services for pharmaceutical manufacturers and research facilities, and capital equipment.

18

STERIS PLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)—(Continued)
For the Three and Six Months Ended September 30, 2018 and 2017
(dollars in thousands, except as noted)



Our Applied Sterilization Technologies segment offers contract sterilization and laboratory services for medical device and pharmaceutical Customers and others.
We disclose a measure of segment income that is consistent with the way management operates and views the business. The accounting policies for reportable segments are the same as those for the consolidated Company. In fiscal 2019, we ceased the allocation of certain corporate costs to our segments to align with internal management measures. The prior period operating income measures have been recast for comparability.
Segment income is calculated as the segment’s gross profit less direct costs and indirect costs if the resources are dedicated to a single segment. Corporate costs include corporate and administrative functions, public company costs, legacy post-retirement benefits, and certain services and facilities related to distribution and research and development that are shared by multiple segments. Adjustments include acquisition related costs, amortization of acquired intangibles, restructuring costs and other charges that management believes may or may not recur with similar materiality or impact on operating income in future periods. Management believes that by adjusting for these items they gain better insight and greater transparency into the operating performance of the segments, thus aiding them in more meaningful financial trend analysis and operational decision making.
For the three and six months ended September 30, 2018, revenues from a single Customer did not represent ten percent or more of any reportable segment’s revenues. Additional information regarding our segments is included in our consolidated financial statements included in our Annual Report on Form 10-K for the year ended March 31, 2018, dated May 30, 2018.
Financial information for each of our segments is presented in the following table:
 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 
 
 
 
 
 
 
Healthcare Products
 
$
321,505

 
$
302,094

 
$
613,515

 
$
591,158

Healthcare Specialty Services
 
124,554

 
116,111

 
246,803

 
229,545
Life Sciences
 
97,165

 
89,461

 
182,120

 
170,396
Applied Sterilization Technologies
 
135,737

 
126,493

 
275,281

 
251,024
Total revenues
 
$
678,961

 
$
634,159

 
$
1,317,719

 
$
1,242,123

Segment operating income:
 
 
 
 
 
 
 
 
Healthcare Products
 
$
72,468

 
$
63,159

 
$
134,190

 
$
126,283

Healthcare Specialty Services
 
15,461

 
15,950

 
28,415

 
30,294

Life Sciences
 
33,266

 
31,303

 
63,131

 
58,173

Applied Sterilization Technologies
 
53,468

 
48,528

 
109,619

 
96,522

Corporate
 
(46,985
)
 
(38,173
)
 
(93,027
)
 
(84,006
)
Total segment operating income
 
$
127,678

 
$
120,767

 
$
242,328

 
$
227,266

Less: Adjustments
 
 
 
 
 
 
 
 
Restructuring charges
 
$

 
$
27

 
$

 
$
78

Amortization of acquired intangible assets (1)
 
16,956

 
17,171

 
35,013

 
33,473

Acquisition and integration related charges (2)
 
2,707

 
3,393

 
4,378

 
7,422

          (Gain) on fair value adjustment of acquisition related contingent consideration (1)
 

 

 
(842
)
 

Net loss on divestiture of businesses (1)
 
221

 
1,010

 
663

 
1,134

Amortization of property "step up" to fair value (1)
 
615

 
649

 
1,226

 
1,267

Redomiciliation costs (3)
 
600

 

 
887

 

Total operating income
 
$
106,579

 
$
98,517

 
$
201,003

 
$
183,892


19

STERIS PLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)—(Continued)
For the Three and Six Months Ended September 30, 2018 and 2017
(dollars in thousands, except as noted)




(1) For more information regarding our recent acquisitions and divestitures see Note 2 titled, "Business Acquisitions and Divestitures", as well as our Annual Report on Form 10-K for the year ended March 31, 2018, dated May 30, 2018.
(2) Acquisition and integration related charges include transaction costs and integration expenses associated with acquisitions.
(3) Costs incurred in connection with the proposal to redomicile. For more information see Note 18 titled, "Proposal to Redomicile".
Additional information regarding our revenue is disclosed in the following tables:
 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Healthcare Products:
 
 
 
 
 
 
 
 
Capital equipment
 
$
133,410

 
$
119,435

 
$
240,906

 
$
225,000

Consumables
 
101,680

 
100,844

 
202,094

 
204,532

Service
 
86,415

 
81,815

 
170,515

 
161,626

Total Healthcare Products Revenues
 
$
321,505

 
$
302,094

 
$
613,515

 
$
591,158

Total Healthcare Specialty Services Revenues
 
$
124,554

 
$
116,111

 
$
246,803

 
$
229,545

Life Sciences:
 
 
 
 
 
 
 
 
Capital equipment

 
$
29,812

 
$
23,475

 
$
48,926

 
$
41,756

Consumables
 
38,466

 
37,639
 
78,687

 
75,958
Service
 
28,887

 
28,347
 
54,507

 
52,682
Total Life Sciences Revenues
 
$
97,165

 
$
89,461

 
$
182,120

 
$
170,396

Applied Sterilization Technologies Service Revenues
 
$
135,737

 
$
126,493

 
$
275,281

 
$
251,024

Total Revenues
 
$
678,961

 
$
634,159

 
$
1,317,719

 
$
1,242,123

 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 
 
 
 
 
 
United Kingdom
$
44,527

 
$
54,587

 
$
92,007

 
$
107,309

United States
481,233

 
446,708

 
928,773

 
869,667

Other locations
153,201

 
132,864

 
296,939

 
265,147

Total Revenues
$
678,961

 
$
634,159

 
$
1,317,719

 
$
1,242,123

10. Shares and Preferred Shares
Ordinary shares
We calculate basic earnings per share based upon the weighted average number of shares outstanding. We calculate diluted earnings per share based upon the weighted average number of shares outstanding plus the dilutive effect of share equivalents calculated using the treasury stock method.

20

STERIS PLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)—(Continued)
For the Three and Six Months Ended September 30, 2018 and 2017
(dollars in thousands, except as noted)



The following is a summary of shares and share equivalents outstanding used in the calculations of basic and diluted earnings per share:
 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
Denominator (shares in thousands):
 
2018
 
2017
 
2018
 
2017
Weighted average shares outstanding—basic
 
84,537

 
85,199

 
84,611

 
85,145

Dilutive effect of share equivalents
 
940

 
670

 
882

 
650

Weighted average shares outstanding and share equivalents—diluted
 
85,477

 
85,869

 
85,493

 
85,795

Options to purchase the following number of shares were outstanding but excluded from the computation of diluted earnings per share because the combined exercise prices, unamortized fair values, and assumed tax benefits upon exercise were greater than the average market price for the shares during the periods, so including these options would be anti-dilutive:
 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
(shares in thousands)
 
2018
 
2017
 
2018
 
2017
Number of share options
 
418

 
416

 
279

 
492

Preferred Shares
Pursuant to an engagement letter dated October 23, 2015, we issued 100,000 preferred shares, par value of £0.10 each, for an aggregate consideration of approximately $15, in satisfaction of debt owed to a service provider. The holders of the preferred shares are entitled to a fixed cumulative preferential annual dividend of 5 percent on the amount paid periodically on the preferred shares respectively held by them. On a return of capital of the Company whether on liquidation or otherwise, the holders of the preferred shares shall be entitled to receive the sum of £0.10 per preferred share plus any accrued but unpaid dividends out of the assets of the Company available for distribution to its shareholders, but will not be entitled to any further participation in the assets of the Company. The holders of the preferred shares have no right to attend, speak or vote, whether in person or by proxy, at any general meeting of the Company or any meeting of a class of members of the Company in respect of the preferred shares and are not entitled to receive any notice of meetings.
11. Repurchases of Ordinary Shares
On August 9, 2016, the Company announced that its Board of Directors had authorized the purchase of up to $300 million of our ordinary shares. We may enter into share repurchase contracts until August 2, 2021 to effect these purchases. Shares may be repurchased from time to time through open market transactions, including 10b5-1 plans. The repurchase program may be suspended or discontinued at any time. During the first half of fiscal 2019, we repurchased 445,700 of our ordinary shares for the aggregate amount of $47,331 pursuant to this authorization.
During the first half of fiscal 2019, we obtained 100,647 of our ordinary shares in the aggregate amount of $7,799 in connection with share based compensation award programs.

21

STERIS PLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)—(Continued)
For the Three and Six Months Ended September 30, 2018 and 2017
(dollars in thousands, except as noted)



12. Share-Based Compensation
We maintain a long-term incentive plan that makes available shares for grants, at the discretion of the Compensation Committee of the Board of Directors, or the Board of Directors, to officers, directors, and key employees in the form of stock options, restricted shares, restricted share units, stock appreciation rights and share grants. We satisfy share award incentives through the issuance of new ordinary shares.
Stock options provide the right to purchase our shares at the market price on the date of grant, or for options granted in fiscal 2019, 110% of the market price on the date of grant, subject to the terms of the option plan and agreements. Generally, one-fourth of the stock options granted become exercisable for each full year of employment following the grant date. Stock options granted generally expire 10 years after the grant date, or in some cases earlier if the option holder is no longer employed by us. Restricted shares and restricted share units generally cliff vest after a four year period or vest in tranches of one-fourth of the number granted for each full year of employment after the grant date. As of September 30, 2018, 4,400,810 shares remained available for grant under the long-term incentive plan.
The fair value of stock option awards was estimated at their grant date using the Black-Scholes-Merton option pricing model. This model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable, characteristics that are not present in our option grants. If the model permitted consideration of the unique characteristics of employee stock options, the resulting estimate of the fair value of the stock options could be different. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our Consolidated Statements of Income. The expense is classified as cost of goods sold or selling, general and administrative expenses in a manner consistent with the employee’s compensation and benefits.
The following weighted-average assumptions were used for options granted during the first six months of fiscal 2019 and 2018:
 
 
Fiscal 2019
 
Fiscal 2018
Risk-free interest rate
 
2.63%
 
2.01%
Expected life of options
 
6.2 years
 
5.7 years
Expected dividend yield of stock
 
1.47%
 
1.58%
Expected volatility of stock
 
19.92%
 
22.08%
The risk-free interest rate is based upon the U.S. Treasury yield curve. The expected life of options is reflective of historical experience, vesting schedules and contractual terms. The expected dividend yield of stock represents our best estimate of the expected future dividend yield. The expected volatility of stock is derived by referring to our historical stock prices over a time frame similar to that of the expected life of the grant. An estimated forfeiture rate of 2.37% and 2.25% was applied in fiscal 2019 and 2018, respectively. This rate is calculated based upon historical activity and represents an estimate of the granted options not expected to vest. If actual forfeitures differ from this calculated rate, we may be required to make additional adjustments to compensation expense in future periods. The assumptions used above are reviewed at the time of each significant option grant, or at least annually.
A summary of share option activity is as follows:
 
 
Number of
Options
 
Weighted
Average
Exercise
Price
 
Average
Remaining
Contractual
Term
 
Aggregate
Intrinsic
Value
Outstanding at March 31, 2018
 
2,021,662

 
$
58.56

 
 
 
 
Granted
 
426,653

 
114.24

 
 
 
 
Exercised
 
(114,206
)
 
43.35

 
 
 
 
Forfeited
 
(9,819
)
 
75.76

 
 
 
 
Outstanding at September 30, 2018
 
2,324,290

 
$
69.46

 
6.9 years
 
$
104,462

Exercisable at September 30, 2018
 
1,385,735

 
$
54.86

 
5.6 years
 
$
82,515

We estimate that 912,444 of the non-vested stock options outstanding at September 30, 2018 will ultimately vest.

22

STERIS PLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)—(Continued)
For the Three and Six Months Ended September 30, 2018 and 2017
(dollars in thousands, except as noted)



The aggregate intrinsic value in the table above represents the total pre-tax difference between the $114.40 closing price of our ordinary shares on September 30, 2018 over the exercise prices of the stock options, multiplied by the number of options outstanding or outstanding and exercisable, as applicable. The aggregate intrinsic value is not recorded for financial accounting purposes and the value changes daily based on the daily changes in the fair market value of ordinary shares.
The total intrinsic value of stock options exercised during the first six months of fiscal 2019 and fiscal 2018 was $7,216 and $10,243, respectively. Net cash proceeds from the exercise of stock options were $4,857 and $7,726 for the first six months of fiscal 2019 and fiscal 2018, respectively.
The weighted average grant date fair value of stock option grants was $18.05 and $15.51 for the first six months of fiscal 2019 and fiscal 2018, respectively.
Stock appreciation rights (“SARS”) carry generally the same terms and vesting requirements as stock options except that they are settled in cash upon exercise and therefore, are classified as liabilities. The fair value of the outstanding SARS as of September 30, 2018 and 2017 was $762 and $1,853, respectively.
A summary of the non-vested restricted share and share unit activity is presented below:
 
 
Number of
Restricted
Shares
 
Number of Restricted Share Units
 
Weighted-Average
Grant Date
Fair Value
Non-vested at March 31, 2018
 
763,201

 
35,431

 
$
68.85

Granted
 
171,908

 
19,508

 
104.54

Vested
 
(223,527
)
 
(20,440
)
 
61.73

Forfeited
 
(23,800
)
 

 
75.62

Non-vested at September 30, 2018
 
687,782

 
34,499

 
$
80.29

Restricted shares granted are valued based on the closing stock price at the grant date. The value of restricted shares and units that vested during the first six months of fiscal 2019 was $15,060.
As of September 30, 2018, there was a total of $48,812 in unrecognized compensation cost related to non-vested share-based compensation granted under our share-based compensation plan. We expect to recognize the cost over a weighted average period of 2.32 years.
13. Financial and Other Guarantees
We generally offer a limited parts and labor warranty on capital equipment. The specific terms and conditions of those warranties vary depending on the product sold and the countries where we conduct business. We record a liability for the estimated cost of product warranties at the time product revenues are recognized. The amounts we expect to incur on behalf of our Customers for the future estimated cost of these warranties are recorded as a current liability on the accompanying Consolidated Balance Sheets. Factors that affect the amount of our warranty liability include the number and type of installed units, historical and anticipated rates of product failures, and material and service costs per claim. We periodically assess the adequacy of our recorded warranty liabilities and adjust the amounts as necessary.
Changes in our warranty liability during the first half of fiscal 2019 were as follows:
 
Warranties
Balance, March 31, 2018
$
6,872

Warranties issued during the period
5,715

Settlements made during the period
(5,561
)
Balance, September 30, 2018
$
7,026


14. Derivatives and Hedging

23

STERIS PLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)—(Continued)
For the Three and Six Months Ended September 30, 2018 and 2017
(dollars in thousands, except as noted)



From time to time, we enter into forward contracts to hedge potential foreign currency gains and losses that arise from transactions denominated in foreign currencies, including inter-company transactions. We may also enter into commodity swap contracts to hedge price changes in nickel that impact raw materials included in our cost of revenues. During the first half of fiscal 2019, we also entered into forward foreign currency contracts in order to hedge a portion of our expected non-U.S. dollar denominated earnings against our reporting currency, the U.S. dollar. These foreign currency exchange contracts will mature during fiscal 2019. We did not elect hedge accounting for these forward foreign currency contracts; however, we may seek to apply hedge accounting in future scenarios. We do not use derivative financial instruments for speculative purposes.
These contracts are not designated as hedging instruments and do not receive hedge accounting treatment; therefore, changes in their fair value are not deferred but are recognized immediately in the Consolidated Statements of Income. At September 30, 2018, we held foreign currency forward contracts to buy 154.4 million Mexican pesos and 10.8 million Canadian dollars; and to sell 4.1 million euros. At September 30, 2018, we held commodity swap contracts to buy 319.8 thousand pounds of nickel.
 
 
Asset Derivatives
 
Liability Derivatives
 
 
Fair Value at
 
Fair Value at
 
Fair Value at
 
Fair Value at
Balance sheet location
 
September 30, 2018
 
March 31, 2018
 
September 30, 2018
 
March 31, 2018
Prepaid & Other
 
$
234

 
$
187

 
$

 
$

Accrued expenses and other
 

 

 
87

 

The following table presents the impact of derivative instruments and their location within the Consolidated Statements of Income:
 
 
Location of gain (loss)
recognized in income
 
Amount of gain (loss) recognized in income
Three Months Ended September 30,
 
Six Months Ended September 30,
2018
 
2017
 
2018
 
2017
Foreign currency forward contracts
 
Selling, general and administrative
 
$
746

 
$
321

 
$
388

 
$
(516
)
Commodity swap contracts
 
Cost of revenues
 
$
(395
)
 
$
196

 
$
(31
)
 
$
26

Additionally, we hold our debt in multiple currencies to fund our operations and investments in certain subsidiaries. We designate portions of foreign currency denominated intercompany loans as hedges of portions of net investments in foreign operations. Net debt designated as non-derivative net investment hedging instruments totaled $53,755 at September 30, 2018. These hedges are designed to be fully effective and any associated gain or loss is recognized in Accumulated Other Comprehensive Income and will be reclassified to income in the same period when a gain or loss related to the net investment in the foreign operation is included in income.

24

STERIS PLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)—(Continued)
For the Three and Six Months Ended September 30, 2018 and 2017
(dollars in thousands, except as noted)



15. Fair Value Measurements
Fair value is defined as the price that would be received to sell an asset or that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. We estimate the fair value of financial assets and liabilities using available market information and generally accepted valuation methodologies. The inputs used to measure fair value are classified into three tiers. These tiers include Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring the entity to develop its own assumptions.
The following table shows the fair value of our financial assets and liabilities at September 30, 2018 and March 31, 2018:
 
 
 
 
 
Fair Value Measurements
 
 
Carrying Value
 
Quoted Prices
in Active Markets
for Identical Assets
 
Significant Other
Observable Inputs
 
Significant
Unobservable
Inputs
 
 
 
Level 1
 
Level 2
 
Level 3
September 30
March 31
 
September 30
March 31
 
September 30
March 31
 
September 30
March 31
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
209,921

$
201,534

 
$
209,921

$
201,534

 
$

$

 
$

$

Forward and swap contracts (1)
 
234

187

 


 
234

187

 


Equity Investments (2)
 
$
14,566

12,961

 
14,566

12,961

 


 


Other investments
 
3,232

3,421

1

3,232

3,421







Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Forward and swap contracts (1)
 
$
87

$

 
$

$

 
$
87

$

 
$

$

Deferred compensation plans (2)
 
1,794

1,694

 
1,794

1,694

 


 


Long term debt (3)
 
$
1,267,723

1,316,001

 


 
1,238,711

1,305,181

 


Contingent consideration obligations (4)
 
7,054

8,068

 


 


 
7,054

8,068

(1) The fair values of forward and swap contracts are based on period-end forward rates and reflect the value of the amount that we would pay or receive for the contracts involving the same notional amounts and maturity dates.
(2) We maintain a frozen domestic non-qualified deferred compensation plan covering certain employees, which allows for the deferral of payment of previously earned compensation for an employee-specified term or until retirement or termination. Amounts deferred can be allocated to various hypothetical investment options (compensation deferrals have been frozen under the plan). We hold investments to satisfy the future obligations of the plan. Employees who made deferrals are entitled to receive distributions of their hypothetical account balances (amounts deferred, together with earnings (losses)). We also hold an investment in the common stock of Servizi Italia, S.p.A, a leading provider of integrated linen washing and outsourced sterile processing services to hospital Customers. Beginning in fiscal 2019, changes in the fair value of these investments are recorded in the "Interest income and miscellaneous expense line" of the Consolidated Statement of Income. During the second quarter and first half of fiscal 2019, we recorded losses of $1,132 and $2,510 respectively, related to these investments.
(3) We estimate the fair value of our long-term debt using discounted cash flow analyses, based on our current incremental borrowing rates for similar types of borrowing arrangements.
(4) Contingent consideration obligations arise from business acquisitions. The fair values are based on discounted cash flow analyses reflecting the possible achievement of specified performance measures or events and captures the contractual nature of the contingencies, commercial risk, and the time value of money. Contingent consideration obligations are classified in the consolidated balance sheets as accrued expense (short-term) and other liabilities (long-term), as appropriate based on the contractual payment dates.



25

STERIS PLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)—(Continued)
For the Three and Six Months Ended September 30, 2018 and 2017
(dollars in thousands, except as noted)



The changes in Level 3 assets and liabilities measured at fair value on a recurring basis at September 30, 2018 are summarized as follows:
 
 
Contingent Consideration
Balance at March 31, 2018
 
$
8,068

Additions
 
217

Payments
 
(220
)
Reductions
 
(841
)
Currency translation adjustments
 
(170
)
Balance at September 30, 2018
 
$
7,054


16. Reclassifications Out of Accumulated Other Comprehensive Income (Loss)
Amounts in Accumulated Other Comprehensive Income (Loss) are presented net of the related tax. Currency Translation is not adjusted for income taxes. Changes in our Accumulated Other Comprehensive Income (Loss) balances, net of tax, for the three and six months ended September 30, 2018 and 2017 were as follows:
 
Gain (Loss) on Available for Sale Securities (1)
 
Defined Benefit Plans (2)
 
Currency Translation (3)
Total Accumulated Other Comprehensive Income
(Loss)
 
Three Months
Six Months
 
Three Months
Six Months
 
Three Months
Six Months
 
Three Months
Six Months
Beginning Balance
$

$
1,970

 
$
(7,152
)
$
(6,742
)
 
$
(113,944
)
$
16,457

 
$
(121,096
)
$
11,685

Other Comprehensive Income (Loss) before reclassifications


 
150

303

 
(5,271
)
(135,672
)
 
(5,121
)
(135,369
)
Amounts reclassified from Accumulated Other Comprehensive Income (Loss)


 
(563
)
(1,126
)
 


 
(563
)
(1,126
)
Net current-period Other Comprehensive Income (Loss)


 
(413
)
(823
)
 
(5,271
)
(135,672
)
 
(5,684
)
(136,495
)
Cumulative adjustment to Retained Earnings (1)
$

$
(1,970
)
 
$

$

 
$

$

 
$

$
(1,970
)
Balance at September 30, 2018
$

$

 
$
(7,565
)
$
(7,565
)
 
$
(119,215
)
$
(119,215
)
 
$
(126,780
)
$
(126,780
)
(1) As a result of the adoption of ASC 2016-01 we recorded a cumulative effect adjustment to our opening fiscal 2019 retained earnings balance that increased retained earnings and decreased accumulated other comprehensive income. See Footnote 1 titled "Nature of Operations and Summary of Significant Accounting Policies" for further details.
(2) Amortization (gain) of defined benefit plan items are reported in the Interest income and miscellaneous expense line of our Consolidated Statements of Income.
(3) The effective portion of gain or loss on net debt designated as non-derivative net investment hedging instruments is recognized in Accumulated Other Comprehensive Income and is reclassified to income in the same period when a gain or loss related to the net investment is included in income.


26

STERIS PLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)—(Continued)
For the Three and Six Months Ended September 30, 2018 and 2017
(dollars in thousands, except as noted)




 
Gain (Loss) on Available for Sale Securities (1)
 
Defined Benefit Plans (2)
 
Currency Translation (3)
Total Accumulated Other Comprehensive Income
(Loss)
 
Three Months
Six Months
 
Three Months
Six Months
 
Three Months
Six Months
 
Three Months
Six Months
Beginning Balance
$
846

$
178

 
$
(2,759
)
$
(2,355
)
 
$
(145,664
)
$
(238,525
)
 
$
(147,577
)
$
(240,702
)
Other Comprehensive Income (Loss) before reclassifications
1,094

1,745

 
120

240

 
66,819

159,680

 
68,033

161,665

Amounts reclassified from Accumulated Other Comprehensive Income (Loss)
9

26

 
(524
)
(1,048
)
 


 
(515
)
(1,022
)
Net current-period Other Comprehensive Income (Loss)
1,103

1,771

 
(404
)
(808
)
 
66,819

159,680

 
67,518

160,643

Balance at September 30, 2017
$
1,949

$
1,949

 
$
(3,163
)
$
(3,163
)
 
$
(78,845
)
$
(78,845
)
 
$
(80,059
)
$
(80,059
)

(1) Realized gain (loss) on available for sale securities is reported in the Interest income and miscellaneous expense line of the Consolidated Statements of Income.
(2) Amortization (gain) of defined benefit plan items are reported in the Selling, general and administrative expense line of the Consolidated Statements of Income.
(3) The effective portion of gain or loss on net debt designated as non-derivative net investment hedging instruments is recognized in Accumulated Other Comprehensive Income and is reclassified to income in the same period when a gain or loss related to the net investment is included in income.



27

STERIS PLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)—(Continued)
For the Three and Six Months Ended September 30, 2018 and 2017
(dollars in thousands, except as noted)



17. Loans Receivable
In connection with a fiscal 2019 first quarter equity investment of $4,955, we agreed to provide a credit facility of up to approximately $10,000 for a term of up to five years. Loans carry an interest rate of 4% compounded daily and interest is payable annually. Outstanding borrowings under the agreement totaled $5,007 at September 30, 2018.
In connection with the fiscal 2017 divestiture of Synergy Health Netherlands Linen Management Services, we entered into a loan agreement to provide financing of up to €15,000 for a term of up to 15 years. Loans carry an interest rate of 4% for the first four years and 12% thereafter. Outstanding borrowings under the agreement totaled $4,085 (or €3,500) at September 30, 2018.
Amounts for loan receivables as noted above are recorded in the "Other assets" line of our Consolidated balance sheets. Interest income is not material.
18. Proposal to Redomicile
As a result of the anticipated withdrawal of the United Kingdom from the European Union (“Brexit”), entities such as the Company that are organized under the laws of England and Wales are expected to lose the benefit of the tax and other treaties between the U.S. and European Union ("EU").Without further action by the United Kingdom and U.S. governments, the Company may consequentially be subject to higher tax liabilities, which may be significant.
We have evaluated several alternatives due to Brexit’s continuing risks and uncertainties and concluded that redomiciling the Company to Ireland is the best path forward. Maintaining the Company’s domicile in a EU member country is anticipated to preserve the current and significant future financial benefits initially established in 2015 at the time of the Combination with Synergy. The effect of the redomiciliation will be to establish a new holding company for the Company, but it is not expected to materially change the day-to-day operations of the business. We anticipate completing the redomiciliation prior to March 29, 2019, which is the date Brexit is scheduled to occur. However, the proposal is subject to approval by the Company’s shareholders and the English courts, and it is possible that the redomicile may be delayed or not occur.


28



Report of Independent Registered Public Accounting Firm


To the Shareholders and Board of Directors of STERIS plc

Results of Review of Interim Financial Statements

We have reviewed the accompanying consolidated balance sheet of STERIS plc and subsidiaries (the Company) as of September 30, 2018, the related consolidated statements of income and comprehensive income for the three- and six-month periods ended September 30, 2018 and 2017, the consolidated statements cash flows for the six-month periods ended September 30, 2018 and 2017, and the related notes (collectively referred to as the “consolidated interim financial statements”). Based on our reviews, we are not aware of any material modifications that should be made to the consolidated interim financial statements for them to be in conformity with U.S. generally accepted accounting principles.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheet of the Company as of March 31, 2018, the related consolidated statements of income, comprehensive income, shareholders' equity and cash flows for the year then ended, and the related notes and schedule (not presented herein); and in our report dated May 30, 2018, we expressed an unqualified audit opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of March 31, 2018, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

Basis for Review Results

These financial statements are the responsibility of the Company's management. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the SEC and the PCAOB. We conducted our review in accordance with the standards of the PCAOB. A review of interim financial statements consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the PCAOB, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.





/s/ Ernst & Young LLP

Cleveland, Ohio
November 6, 2018


29



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 2019 and fiscal 2018. It may also be helpful to read the MD&A in our Annual Report on Form 10-K for the year ended March 31, 2018, dated May 30, 2018. 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; 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.
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 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 and instrument and scope repairs as well as revenues generated from contract sterilization and laboratory services offered through our Applied Sterilization Technologies segment.

30


Capital Equipment Revenues – We define capital equipment 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 Company Overview and Executive Summary
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.
We operate and report our financial information in four reportable business segments: Healthcare Products, Healthcare Specialty Services, Life Sciences, and Applied Sterilization Technologies. We describe our business segments in Note 9 to our consolidated financial statements, titled "Business Segment Information."
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 regulatory 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 continue to invest in manufacturing in-sourcing projects and lean process improvements for the purpose of improving quality, cost and delivery of our products and services to our Customers.
U.S. Tax Reform. On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “TCJA”). The TCJA makes broad and complex changes to the U.S. tax code that will affect the Company’s fiscal year ending March 31, 2019 and forward, including, but not limited to, (1) reduction of the U.S. federal corporate income tax rate; (2) elimination of the corporate alternative minimum tax ("AMT"); (3) the creation of the base erosion anti-abuse tax ("BEAT"), a new minimum tax; (4) a general elimination of U.S. federal income taxes on dividends from non-U.S. subsidiaries; (5) a new provision designed to tax global intangible low-taxed income ("GILTI"), which allows for the possibility of using foreign tax credits ("FTCs") and a deduction of up to 50 percent to offset the income tax liability (subject to some limitations); (6) a new limitation on deductible interest expense; (7) the repeal of the domestic production activity deduction; (8) limitations on the deductibility of certain executive compensation; (9) limitations on the use of FTCs to reduce the U.S. income tax liability; and (10) limitations on net operating losses ("NOLs") generated after December 31, 2017, to 80.0 percent of taxable income.
Highlights. Revenues for the second quarter of fiscal 2019 were $679.0 million, representing an increase of 7.1% over the second quarter of fiscal 2018 revenues of $634.2 million. Revenues for the first half of fiscal 2019 were $1,317.7 million, representing an increase of 6.1% over the revenues for the first half of fiscal 2018 of $1,242.1 million. The fiscal 2019 revenue increase over the prior year periods were attributable to organic growth in all business segments, which was partially offset by the impact of our fiscal 2018 divestiture of Synergy Health Healthcare Consumable Solutions ("HCS"). Fluctuations in currencies added unfavorable impact in the fiscal 2019 quarter-to-date period and favorable impact in the fiscal 2019 year-to-date period.
Gross margin percentage for the second quarter of fiscal 2019 was 41.9% compared with 42.0% for the second quarter of fiscal 2018. The slight decrease was primarily attributable to the negative impact of investments in outsourced reprocessing in the United States and mix with a shift toward capital equipment revenues, which was partially offset by favorable pricing and fluctuations in currencies, and the positive impact of our recent divestitures. Gross margin percentage for the first half of fiscal 2019 remained flat at 42.0% as compared with the first half of fiscal 2018. The favorable impacts of the divestiture of HCS and pricing were offset by investments in outsourced reprocessing and other adjustments.
Operating income during the second quarter of fiscal 2019 was $106.6 million compared to $98.5 million for the second quarter of fiscal 2018. Operating income during the first half of fiscal 2019 was $201.0 million, compared to $183.9 million for

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the first half of fiscal 2018. The fiscal 2019 increases over the prior year periods were primarily attributable to increased volumes.
Cash flows from operations were $226.7 million and free cash flow was $169.7 million in the first six months of fiscal 2019 compared to cash flows from operations of $217.4 million and free cash flow of $144.0 million in the first six months of fiscal 2018 (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 fiscal 2019 increases in cash flows from operations and free cash flow over fiscal 2018 were primarily due to higher earnings and the timing of capital expenditures.
Our debt-to-total capital ratio was 28.9% at September 30, 2018 and 29.1% at March 31, 2018. During the first half of fiscal 2019, we declared and paid quarterly cash dividends of $0.65 per ordinary share.
Additional information regarding our financial performance during the second quarter and first half of fiscal 2019 is included in the subsection below titled “Results of Operations.”

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, and intangibles, which are also presented within investing activities 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 six months ended September 30, 2018 and 2017: 
 
 
Six Months Ended September 30,
(dollars in thousands)
 
2018
 
2017
Net cash provided by operating activities
 
$
226,702

 
$
217,377

Purchases of property, plant, equipment and intangibles, net
 
(62,549
)
 
(75,420
)
Proceeds from the sale of property, plant, equipment and intangibles
 
5,547

 
2,075

Free cash flow
 
$
169,700

 
$
144,032

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 2019 compared with the same fiscal 2018 periods. We begin with a general overview of our operating results and then separately discuss earnings for our operating segments.

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Revenues. The following tables compare our revenues for the three and six months ended September 30, 2018 to the revenues for the three and six months ended September 30, 2017:
 
 
Three Months Ended September 30,
 
 
 
 
(dollars in thousands)
 
2018
 
2017
 
Change
 
Percent Change
 
 
 
 
 
 
 
 
 
Total revenues
 
$
678,961

 
$
634,159

 
$
44,802

 
7.1
 %
 
 
 
 
 
 
 
 
 
Revenues by type:
 
 
 
 
 
 
 
 
Service revenues
 
364,302

 
347,602

 
16,700

 
4.8
 %
Consumable revenues
 
147,172

 
141,241

 
5,931

 
4.2
 %
Capital equipment revenues
 
167,487

 
145,316

 
22,171

 
15.3
 %
 
 
 
 
 
 
 
 
 
Revenues by geography:
 
 
 
 
 
 
 
 
United Kingdom revenues
 
44,527

 
54,587

 
(10,060
)
 
(18.4
)%
United States revenues
 
481,233

 
446,708

 
34,525

 
7.7
 %
Other foreign revenues
 
153,201

 
132,864

 
20,337

 
15.3
 %

 
 
Six Months Ended September 30,
 
 
 
 
(dollars in thousands)
 
2018
 
2017
 
Change
 
Percent Change
 
 
 
 
 
 
 
 
 
Total revenues
 
$
1,317,719