News Column

STERIS CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

August 8, 2014

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, repurchase common 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 first quarter of fiscal 2015 and fiscal 2014. It may also be helpful to read the MD&A in our Annual Report on Form 10-K for the year ended March 31, 2014, dated May 29, 2014. In the MD&A, we analyze and explain the period-over-period changes in the specific line items in the Consolidated Statements of Income. Our analysis may be important to you in making decisions about your investments in STERIS.



Financial Measures

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



• Backlog - We define backlog as the amount of unfilled capital equipment

purchase orders at a point in time. We use this figure as a measure to

assist in the projection of short-term financial results and inventory

requirements. • Debt-to-total capital - We define debt-to-total capital as total debt divided by the sum of total debt and shareholders' equity. We use this



figure as a financial liquidity measure to gauge our ability to borrow and

fund growth.

• Net debt-to-total capital - We define net debt-to-total capital as total

debt less cash ("net debt") divided by the sum of net debt and

shareholders' equity. We also use this figure as a financial liquidity

measure to gauge our ability to borrow and fund growth.

• Days sales outstanding ("DSO") - We define DSO as the average collection

period for accounts receivable. It is calculated as net accounts

receivable divided by the trailing four quarters' revenues, multiplied by

365 days. We use this figure to help gauge the quality of accounts receivable and expected time to collect. We, at times, may also refer to 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: 22



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

• Product Revenues - We define product revenues as revenues generated from

sales of consumable and capital equipment products.

• Service Revenues - We define service revenues as revenues generated from

parts and labor associated with the maintenance, repair, and installation

of our capital equipment, instrument repair and endoscope repair services,

and revenues generated from contract sterilization offered through our Isomedix segment.



• Capital Revenues - We define capital revenues as revenues generated from

sales of capital equipment, which includes steam sterilizers, low

temperature liquid chemical sterilant processing systems, including SYSTEM

1 and 1E, washing systems, VHP® technology, water stills, and pure steam

generators; surgical lights and tables; and integrated OR.

• Consumable Revenues - We define consumable revenues as revenues generated

from sales of the consumable family of products, which includes SYSTEM 1

and 1E consumables, V-Pro consumables, gastrointestinal endoscopy

accessories, sterility assurance products, skin care products, cleaning

consumables, and surgical instruments.

• Recurring Revenues - We define recurring revenues as revenues generated

from sales of consumable products and service revenues.

General 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. The bulk of our revenues are derived from the healthcare and pharmaceutical industries. Much of the growth in these industries is driven by the aging of the population throughout the world, as an increasing number of individuals are entering their prime healthcare consumption years, and is dependent upon advancement in healthcare delivery, acceptance of new technologies, government policies, and general economic conditions. In addition, each of our core industries is experiencing specific trends that could increase demand. Within healthcare, there is increased concern regarding the level of hospital-acquired infections around the world. The pharmaceutical industry has been impacted by increased FDA scrutiny of cleaning and validation processes, mandating that manufacturers improve their processes. The aging population increases the demand for medical procedures, which increases the consumption of single use medical devices and surgical kits processed by our Isomedix segment. We are actively pursuing new opportunities to adapt our proven technologies to meet the changing needs of the global marketplace. We also are pursuing a strategy of expanding into adjacent markets with acquisitions in the Healthcare segment. On May 9, 2014, the Company acquired Integrated Medical Systems International, Inc. ("IMS"). IMS has facilities located in Alabama, Florida and Maryland and provides a variety of services, including: endoscope repair, surgical instrument management and sterile processing consulting. IMS will be integrated into our Healthcare segment as part of our Specialty Services business. Fiscal 2015 first quarter revenues were $412.6 million, representing an increase of 12.2% over the prior year, reflecting growth within the Healthcare business segment due to our recent acquisitions, growth within the Europe, Middle East and Africa ("EMEA") and the Asia Pacific regions, and growth within the Isomedix business segment. Our gross margin percentage for the fiscal 2015 first quarter was 41.2% compared to 39.9% in the same fiscal 2014 period. Our gross margin percentage was impacted by the positive impact of foreign currency and favorable product mix. Although our recent acquisitions added value in terms of dollars, they negatively impacted our gross margin percentage, along with rising material costs and inflation. Fiscal 2015 first quarter operating income was $44.2 million compared with $41.0 million for the fiscal 2014 first quarter. The increase in operating income is attributable to the higher gross margin attainment as well as an increase in revenues over the fiscal 2014 first quarter. Cash flows from operations were $46.4 million and free cash flow was $23.1 million in the first three months of fiscal 2015 compared to $32.7 million and $11.0 million in the prior year first three months, respectively (see the subsection below titled "Non-GAAP Financial Measures", for additional information and related reconciliation of cash flows from operations to free cash flow). The increases in cash flow from operations and free cash flow are primarily due to working capital improvements. Our debt-to-total capital ratio was 38.3% at June 30, 2014 and 32.2% at March 31, 2014. During the first three months of fiscal 2015, we declared and paid quarterly cash dividends of $0.21 per common share. Additional information regarding our fiscal 2015 first quarter financial performance is included in the subsection below titled "Results of Operations."



Matters Affecting Comparability

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International Operations. Since we conduct operations outside of the United States using various foreign currencies, our operating results are impacted by foreign currency movements relative to the U.S. dollar. During the first quarter of fiscal 2015, our revenues were favorably impacted by $1.1 million, or 0.26%, and income before taxes was favorably impacted by $2.1 million, or 5.47%, as a result of foreign currency movements relative to the U.S. dollar. NON-GAAP FINANCIAL MEASURES We, at times, refer to financial measures which are considered to be "non-GAAP financial measures" under SEC rules. We, at times, also refer to our results of operations excluding certain transactions or amounts that are non-recurring or are not indicative of future results, in order to provide meaningful comparisons between the periods presented. These non-GAAP financial measures are not intended to be, and should not be, considered separately from or as an alternative to the most directly comparable GAAP financial measures. These non-GAAP financial measures are presented with the intent of providing greater transparency to supplemental financial information used by management and the Board of Directors in their financial analysis and operational decision-making. These amounts are disclosed so that the reader has the same financial data that management uses with the belief that it will assist investors and other readers in making comparisons to our historical operating results and analyzing the underlying performance of our operations for the periods presented. We believe that the presentation of these non-GAAP financial measures, when considered along with our GAAP financial measures and the reconciliation to the corresponding GAAP financial measures, provide the reader with a more complete understanding of the factors and trends affecting our business than could be obtained absent this disclosure. It is important for the reader to note that the non-GAAP financial measure used may be calculated differently from, and therefore may not be comparable to, a similarly titled measure used by other companies. We define free cash flow as net cash provided by operating activities as presented in the Consolidated Statements of Cash Flows less purchases of property, plant, equipment, and intangibles plus proceeds from the sale of property, plant, equipment, and intangibles, which are also presented in the Consolidated Statements of Cash Flows. We use this as a measure to gauge our ability to fund future debt principal repayments, growth outside of core operations, repurchase common shares, and pay cash dividends. The following table summarizes the calculation of our free cash flow for the three month periods ended June 30, 2014 and 2013: Three Months Ended June 30, (dollars in thousands) 2014 2013 Net cash provided by operating activities $



46,353 $ 32,697 Purchases of property, plant, equipment and intangibles, net (23,331 )

(21,741 ) Proceeds from the sale of property, plant, equipment and intangibles 71 8 Free cash flow $ 23,093$ 10,964 Results of Operations In the following subsections, we discuss our earnings and the factors affecting them for the first quarter of fiscal 2015 compared with the same fiscal 2014 period. We begin with a general overview of our operating results and then separately discuss earnings for our operating segments.



Revenues. The following table compares our revenues for the three months ended June 30, 2014 to the revenues for the three months ended June 30, 2013:

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Table of Contents Three Months Ended June 30, (dollars in thousands) 2014 2013 Change Percent Change Total revenues $ 412,643$ 367,652$ 44,991 12.2 % Revenues by type: Capital equipment revenues 120,395 123,894 (3,499 ) (2.8 )% Consumable revenues 110,045 99,034 11,011 11.1 % Service revenues 182,203 144,724 37,479 25.9 % Revenues by geography: United States revenues 317,351 288,353 28,998 10.1 % International revenues 95,292 79,299 15,993 20.2 % Revenues increased $45.0 million, or 12.2%, to $412.6 million for the quarter ended June 30, 2014, as compared to $367.7 million for the same prior year quarter. Capital equipment revenues decreased $3.5 million in the first quarter of fiscal 2015, as compared to the first quarter of fiscal 2014. This decrease was driven primarily by lower volumes within the North America and Latin America regions, which was partially offset by growth within the EMEA and Asia Pacific regions. Consumable revenues increased $11.0 million for the quarter ended June 30, 2014, as compared to the prior year quarter, driven largely by growth within the North America, EMEA and Asia Pacific regions. Service revenues increased $37.5 million in the first quarter of fiscal 2015 primarily driven by the fiscal 2015 acquisition of IMS, increases within the EMEA region, and increases in other service offerings. United States revenues increased $29.0 million, or 10.1%, to $317.4 million for the quarter ended June 30, 2014, as compared to $288.4 million for the same prior year quarter. This increase reflects year over year growth of 10.9% in consumable revenues, and 27.3% year over year growth in service revenues attributable largely to the fiscal 2015 acquisition of IMS. International revenues increased $16.0 million, or 20.2%, to $95.3 million for the quarter ended June 30, 2014, as compared to $79.3 million for the same prior year quarter. This increase reflects revenue growth in product and service revenues, particularly within the EMEA and Asia Pacific regions.



Gross Profit. The following table compares our gross profit for the three months ended June 30, 2014 to the three months ended June 30, 2013:

Three Months Ended June 30, Percent (dollars in thousands) 2014 2013 Change Change Gross profit: Product $ 100,465$ 93,390$ 7,075 7.6 % Service 69,628 53,456 16,172 30.3 % Total gross profit $ 170,093$ 146,846$ 23,247 15.8 % Gross profit percentage: Product 43.6 % 41.9 % Service 38.2 % 36.9 % Total gross profit percentage 41.2 % 39.9 % Our gross profit percentage is affected by the volume, pricing, and mix of sales of our products and services, as well as the costs associated with the products and services that are sold. Gross profit percentage for the first quarter of fiscal 2015 amounted to 41.2% as compared to the first quarter of fiscal 2014 gross profit percentage of 39.9%. The gross profit percentage increased 130 basis points. Our gross profit percentage was impacted by the positive impact of foreign currency (20 basis 25



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points) and favorable product mix and other (200 basis points). Although our recent acquisitions added value in terms of dollars, they negatively impacted our gross margin percentage by approximately 70 basis points. Rising material costs and inflation also negatively impacted our gross margin percentage by approximately 10 basis points each, respectively.



Operating Expenses. The following table compares our operating expenses for the three months ended June 30, 2014 to the three months ended June 30, 2013:

Three Months Ended June 30, Percent (dollars in thousands) 2014 2013 Change Change Operating expenses: Selling, general, and administrative $ 113,688$ 93,929$ 19,759 21.0 % Research and development 12,409 11,853 556 4.7 % Restructuring expenses (172 ) 52 (224 ) NM Total operating expenses $ 125,925$ 105,834$ 20,091 19.0 % NM - Not meaningful. Significant components of total selling, general, and administrative expenses ("SG&A") are compensation and benefit costs, fees for professional services, travel and entertainment, facilities costs, and other general and administrative expenses. The increase of 21.0% in the first quarter of fiscal 2015 over the first quarter of fiscal 2014 is largely attributable to the addition of operating expenses incurred by our recently acquired businesses. For the three month period ended June 30, 2014, research and development expenses increased 4.7% over the same period in prior year. The increase is primarily attributable to additional expenses incurred by Eschmann Holdings Ltd. which was acquired during the fourth quarter of fiscal year 2014. Research and development expenses also are influenced by the number and timing of in-process projects and labor hours and other costs associated with these projects. Our research and development initiatives continue to emphasize new product development, product improvements, and the development of new technological platform innovations. During the first quarter of fiscal 2015, our investments in research and development continued to be focused on, but were not limited to, enhancing capabilities of sterile processing combination technologies, surgical products and accessories, and devices and support accessories used in gastrointestinal endoscopy procedures. Restructuring expenses incurred during the first quarter of fiscal 2015 related to the previously announced Fiscal 2014 Restructuring Plan. The following table summarizes our total pre-tax restructuring expenses for the first quarter of fiscal 2015: Fiscal 2014 Restructuring Three Months Ended June 30, Plan (1)



(dollars in thousands) Severance and other compensation related costs $ (196 ) Asset impairment and accelerated depreciation

(38 ) Lease termination obligation and other 62 Product rationalization (114 ) Total restructuring expenses $ (286 )



(1) Includes $(114) in expense recorded to cost to revenues on Consolidated Statements of Income.

Pre-tax restructuring expenses of $52 thousand incurred during the first quarter of fiscal 2014 related to previously announced restructuring plans.

Liabilities related to restructuring activities are recorded as current liabilities on the accompanying Consolidated Balance Sheets within "Accrued payroll and other related liabilities" and "Accrued expenses and other." The following table summarizes our restructuring liability balances and activity:

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Table of Contents Fiscal 2014 Restructuring Plan Fiscal 2015 March 31, June 30, (dollars in thousands) 2014 Provision Payments (1) 2014 Severance and termination benefits $ 6,389 $ (196 )$ (1,519 )$ 4,674 Lease termination obligations and other 1,589 - (988 ) 601 Total $ 7,978 $ (196 )$ (2,507 )$ 5,275



(1) Certain amounts reported include the impact of foreign currency movements relative to the U.S. dollar.

Non-Operating Expenses, Net. Non-operating expenses, net consists of interest expense on debt, offset by interest earned on cash, cash equivalents, short-term investment balances, and other miscellaneous income. The following table compares our net non-operating expenses for the three months ended June 30, 2014 and 2013: Three Months Ended June 30, (dollars in thousands) 2014 2013 Change Non-operating expenses, net: Interest expense $ 4,682$ 4,987$ (305 ) Interest income and miscellaneous expense (220 ) (248 ) 28 Non-operating expenses, net $ 4,462$ 4,739$ (277 )



Interest expense during the fiscal 2015 period decreased due to favorable interest rates on outstanding borrowings. Interest income and miscellaneous expense is immaterial.

Income Tax Expense. The following table compares our income tax expense and effective income tax rates for the three months ended June 30, 2014 to the three months ended June 30, 2013:

Three Months Ended June 30, Percent (dollars in thousands) 2014 2013 Change Change Income tax expense $ 15,169$ 3,956$ 11,213 283.4% Effective income tax rate 38.2 % 10.9 % Income tax expense includes United States federal, state and local, and foreign income taxes, and is based on reported pre-tax income. The effective income tax rates for continuing operations for the three month period ended June 30, 2014 was 38.2% compared with 10.9% for the same prior year period. During the first quarter of fiscal 2015, we were unfavorably impacted by pretax losses in jurisdictions for which no tax benefit is recognized. Conversely, during the first quarter of fiscal 2014, we benefited from the recognition of previously unrecognized tax benefits due to the settlement of a federal tax examination. We record income tax expense during interim periods based on our estimate of the annual effective income tax rate, adjusted each quarter for discrete items. We analyze various factors to determine the estimated annual effective income tax rate, 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 carryforwards, and available tax planning alternatives. Business Segment Results of Operations. We operate in three reportable business segments: Healthcare, Life Sciences, and Isomedix. Corporate and other, which is presented separately, contains the Defense and Industrial business unit plus costs that are associated with being a publicly traded company and certain other corporate costs. These costs include executive office costs, Board of Directors compensation, shareholder services and investor relations, external audit fees, and legacy pension and post-retirement benefit costs. Our Annual Report on Form 10-K for the year ended March 31, 2014, dated May 29, 2014, provides additional information regarding each business segment. The following table compares business segment revenues for the three months ended June 30, 2014 and 2013: 27



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Table of Contents Three Months Ended June 30, Percent (dollars in thousands) 2014 2013 Change Change Revenues: Healthcare $ 302,810$ 258,888$ 43,922 17.0 % Life Sciences 58,614 59,915 (1,301 ) (2.2 )% Isomedix 51,193 48,224 2,969 6.2 % Total reportable segments 412,617 367,027 45,590 12.4 % Corporate and other 26 625 (599 ) (95.8 )% Total Revenues $ 412,643$ 367,652$ 44,991 12.2 % Healthcare revenues increased $43.9 million, or 17.0%, to $302.8 million for the quarter ended June 30, 2014, as compared to $258.9 million for the same prior year quarter. This growth reflects increases in capital equipment, consumable and service revenues of 0.6%, 12.4% and 42.7%, respectively. These increases are primarily attributable to the addition of capital equipment and service revenues from our recent acquisitions, as well as organic growth in consumable and service revenues. At June 30, 2014, the Healthcare segment's backlog amounted to $125.0 million, increasing $4.8 million, or 4.0%, compared to the backlog of $120.2 million at June 30, 2013. Life Sciences revenues decreased $1.3 million, or 2.2%, to $58.6 million for the quarter ended June 30, 2014, as compared to $59.9 million for the same prior year quarter. The growth of 6.4% in consumable revenues and 8.7% in service revenues was not enough to offset an 18.4% decline in capital equipment revenues, which was primarily due to the timing of shipments. At June 30, 2014, the Life Sciences segment's backlog amounted to $46.0 million, increasing $1.4 million, or 3.1%, compared to the backlog of $44.6 million at June 30, 2013. Isomedix segment revenues increased $3.0 million, or 6.2%, to $51.2 million for the quarter ended June 30, 2014, as compared to $48.2 million for the same prior year quarter. Revenues were favorably impacted by increased volume from our core medical device Customers.



The following table compares our business segment operating results for the three months ended June 30, 2014 to the three months ended June 30, 2013:

Three Months Ended June 30, Percent (dollars in thousands) 2014 2013 Change Change Operating income: Healthcare $ 17,966$ 14,947$ 3,019 20.2 % Life Sciences 11,945 12,539 (594 ) (4.7 )% Isomedix 16,191 14,718 1,473 10.0 % Total reportable segments 46,102 42,204 3,898 9.2 % Corporate and other (1,934 ) (1,192 ) (742 ) (62.2 )% Total operating income $ 44,168$ 41,012$ 3,156 7.7 % Segment operating income is calculated as the segment's gross profit less direct expenses and indirect cost allocations, which results in the full allocation of all distribution and research and development expenses, and the partial allocation of corporate costs. Corporate cost allocations are based on each segment's percentage of revenues, headcount, or other variables in relation to those of the total Company. In addition, the Healthcare segment is responsible for the management of all but one manufacturing facility and uses standard cost to sell products to the Life Sciences segment. Corporate and other includes the revenues, gross profit and direct expenses of the Defense and Industrial business unit, as well as certain unallocated corporate costs related to being a publicly traded company and legacy pension and post-retirement benefits, as previously discussed. The Healthcare segment's operating income increased $3.0 million to $18.0 million for the first quarter of fiscal 2015, as compared to $14.9 million in the same prior year period. The segment's operating margins were 5.9% and 5.8% for the first quarter of fiscal 2015 and fiscal 2014, respectively, essentially remaining flat year over year. Although our recent acquisitions added to operating income, they negatively impacted our operating margins, as anticipated. 28



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The Life Sciences segment's operating income decreased $0.6 million to $11.9 million for the first quarter of fiscal 2015, as compared to the same prior year period. The segment's operating margins were 20.4% and 20.9% for the first quarter of fiscal 2015 and fiscal 2014, respectively. The decrease was the result of lower revenue offset by favorable product mix and foreign currency impact. The Isomedix segment's operating income increased $1.5 million to $16.2 million for the first quarter of fiscal 2015, as compared to the same prior year period. The segment's operating margins were 31.6% and 30.5% for the first quarter of fiscal 2015 and fiscal 2014, respectively. The increase was the result of increased volume from our core medical device Customers.



Liquidity and Capital Resources

The following table summarizes significant components of our cash flows for the three months ended June 30, 2014 and 2013:

Three Months Ended June 30, (dollars in thousands) 2014 2013 Operating activities: Net income $ 24,537$ 32,317 Non-cash items 21,940 23,321 Changes in operating assets and liabilities (124 ) (22,941 ) Net cash provided by operating activities $ 46,353$ 32,697 Investing activities: Purchases of property, plant, equipment, and intangibles, net $ (23,331 )



$ (21,741 ) Proceeds from the sale of property, plant, equipment, and intangibles

71 8 Investments in businesses, net of cash acquired (179,012 ) (115 ) Net cash used in investing activities $ (202,272 )$ (21,848 ) Financing activities: Proceeds under credit facilities, net $ 165,260$ 21,410 Deferred financing fees and debt issuance costs - (43 ) Repurchases of common shares (5,319 ) (4,775 ) Cash dividends paid to common shareholders (12,459 ) (11,244 ) Stock option and other equity transactions, net 7,150 8,482 Tax benefit from share-based compensation 3,835 718 Net cash provided by financing activities $ 158,467$ 14,548 Debt-to-total capital ratio 38.3 % 34.6 % Free cash flow $ 23,093$ 10,964 Net Cash Provided by Operating Activities - The net cash provided by our operating activities was $46.4 million for the first three months of fiscal 2015 as compared with $32.7 million for the first three months of fiscal 2014. The increase in net cash provided by operating activities in fiscal 2015 is primarily due to working capital improvements.



Net Cash Used In Investing Activities - The net cash used in investing activities totaled $202.3 million for the first three months of fiscal 2015 compared with $21.8 million for the first three months of fiscal 2014. The following discussion summarizes the significant changes in our investing cash flows for the first three months of fiscal 2015 and fiscal 2014:

• Purchases of property, plant, equipment, and intangibles, net - Capital

expenditures were $23.3 million for the first three months of fiscal 2015 as compared to $21.7 million during the same prior year period.



• Investments in businesses, net of cash acquired- During the first quarter

of fiscal 2015, we used $173.2 million of cash for the acquisition of IMS

and related realty. For more information on this acquisition refer to note

18 to our consolidated financial statements titled, "Business

Acquisitions". During the first quarter of fiscal 2015, we also paid a

working capital settlement of $0.8 million and deferred consideration of

$5.0 million for the fiscal 2014 acquisition of Eschmann Holdings Ltd. For

more information on this acquisition refer to our Annual Report on Form 10-K for the year ended March 31, 2014, dated May 29, 2014. Net Cash Provided By Financing Activities - The net cash provided by financing activities amounted to $158.5 million for the first three months of fiscal 2015 compared with net cash provided by financing activities of $14.5 million for the first three 29



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months of fiscal 2014. The following discussion summarizes the significant changes in our financing cash flows for the first three months of fiscal 2015 and fiscal 2014:

• Proceeds under credit facilities- At June 30, 2014, we had $318.7 million

of debt outstanding under our credit facilities, reflecting net borrowings

of $165.3 million. At June 30, 2013, we had $103.7 million of debt

outstanding under our revolving credit facility, reflecting net borrowings

of $21.4 million.

• Repurchases of common shares - During the first three months of fiscal

2015, we obtained 125,998 of our common shares in connection with

share-based compensation award programs for an aggregate amount of $5.3

million. During the same period in fiscal 2014, we paid for the repurchase

of 91,195 of our commons shares and obtained 20,307 of our common shares

in connection with stock based compensation award programs in the aggregate amount of $4.8 million.



• Cash dividends paid to common shareholders - During the first three months

of fiscal 2015, we paid total cash dividends of $12.5 million, or $0.21

per outstanding common share. During the first three months of fiscal

2014, we paid total cash dividends of $11.2 million, or $0.19 per outstanding common share. • Stock option and other equity transactions, net - We receive cash for



issuing common shares under our various employee stock option programs.

During the first three months of fiscal 2015 and fiscal 2014, we received

cash proceeds totaling $7.2 million and $8.5 million, respectively, under

these programs.

• Tax benefit from share-based compensation - During the first three months

of fiscal 2015, we received a total tax benefit from share based

compensation of $3.8 million. During the first three months of fiscal

2014, we received a total tax benefit from share based compensation of

$0.7 million. The increase in the first three months of fiscal 2015 over

the same prior year period was primarily due to an increase in both the

quantity and value of restricted shares vesting and stock options exercised. Cash Flow Measures. Free cash flow was $23.1 million in the first three months of fiscal 2015 compared to $11.0 million in the prior year first three months (see the subsection above titled "Non-GAAP Financial Measures", for additional information and related reconciliation of cash flows from operations to free cash flow). The increase in free cash flow is primarily due to working capital improvements. Our debt-to-total capital ratio was 38.3% at June 30, 2014 and 34.6% at June 30, 2013, reflecting increased borrowings subsequent to the first quarter of the prior year, in part to fund our fiscal 2015 first quarter acquisition of IMS. Sources of Credit and Contractual and Commercial Commitments. Information related to our sources of credit and contractual and commercial commitments is included in our Annual Report on Form 10-K for the year ended March 31, 2014, dated May 29, 2014. Our commercial commitments were approximately $45.8 million at June 30, 2014 reflecting a net decrease of $3.8 million in surety bonds and other commercial commitments from March 31, 2014. Our outstanding borrowing under the Credit Agreement and Swing Line Facility was $318.7 million as of June 30, 2014. There were no letters of credit outstanding under the Credit Agreement at June 30, 2014. Cash Requirements. Currently, we intend to use our existing cash and cash equivalent balances, cash generated from operations, and our existing credit facilities for short-term and long-term capital expenditures and our other liquidity needs. We believe that these amounts will be sufficient to meet working capital needs, capital requirements, and commitments for at least the next twelve months. However, our capital requirements will depend on many uncertain factors, including our rate of sales growth, our Customers' acceptance of our products and services, the costs of obtaining adequate manufacturing capacities, the timing and extent of our research and development projects, and changes in our operating expenses. To the extent that our existing sources of cash are not sufficient to fund our future activities, we may need to raise additional funds through additional borrowings or selling equity securities. We cannot assure you that we will be able to obtain additional funds on terms favorable to us, or at all.



Critical Accounting Policies, Estimates, and Assumptions

Information related to our critical accounting policies, estimates, and assumptions is included in our Annual Report on Form 10-K for the year ended March 31, 2014, dated May 29, 2014. Our critical accounting policies, estimates, and assumptions have not changed materially from March 31, 2014. Contingencies 30



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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 record a liability for such contingencies to the extent we conclude that their occurrence is both probable and estimable. We consider many factors in making these assessments, including the professional judgment of experienced members of management and our legal counsel. We have made estimates as to the likelihood of unfavorable outcomes and the amounts of such potential losses. In our opinion, the ultimate outcome of these proceedings and claims is not anticipated to have a material adverse affect on our consolidated financial position, results of operations, or cash flows. However, the ultimate outcome of proceedings, government investigations, and claims is unpredictable and actual results could be materially different from our estimates. We record expected recoveries under applicable insurance contracts when we are assured of recovery. Refer to Part II, Item 1, "Legal Proceedings" for additional information. We are subject to taxation from United States federal, state and local, and foreign jurisdictions. Tax positions are settled primarily through the completion of audits within each individual tax jurisdiction or the closing of a statute of limitation. Changes in applicable tax law or other events may also require us to revise past estimates. The IRS routinely conducts audits of our federal income tax returns. We are no longer subject to United States federal examinations for years before fiscal 2014 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 2010. We remain subject to tax authority audits in various other jurisdictions in which we operate. If we prevail in matters for which accruals have been recorded, or are required to pay amounts in excess of recorded accruals, our effective income tax rate in a given financial statement period could be materially impacted. Additional information regarding our commitments and contingencies is included in note 9 to our consolidated financial statements titled, "Commitments and Contingencies."



International Operations

Since we conduct operations outside of the United States using various foreign currencies, our operating results are impacted by foreign currency movements relative to the U.S. dollar. During the first quarter of fiscal 2015, our revenues were favorably impacted by $1.1 million, or 0.26%, and income before taxes was favorably impacted by $2.1 million, or 5.47%, as a result of foreign currency movements relative to the U.S. dollar.



Forward-Looking Statements

This Form 10-Q may contain statements concerning certain trends, expectations, forecasts, estimates, or other forward-looking information affecting or relating to the Company or its industry, products or activities that are intended to qualify for the protections afforded "forward-looking statements" under the Private Securities Litigation Reform Act of 1995 and other laws and regulations. Forward-looking statements speak only as to the date of this report, and may be identified by the use of forward-looking terms such as "may," "will," "expects," "believes," "anticipates," "plans," "estimates," "projects," "targets," "forecasts," "outlook," "impact," "potential," "confidence," "improve," "optimistic," "deliver," "comfortable," "trend", and "seeks," or the negative of such terms or other variations on such terms or comparable terminology. Many important factors could cause actual results to differ materially from those in the forward-looking statements including, without limitation, disruption of production or supplies, changes in market conditions, political events, pending or future claims or litigation, competitive factors, technology advances, actions of regulatory agencies, and changes in laws, government regulations, labeling or product approvals or the application or interpretation thereof. Other risk factors are described herein and in the Company's other securities filings, including Item 1A of our Annual Report on Form 10-K for the year ended March 31, 2014 dated May 29, 2014. Many of these important factors are outside STERIS's control. No assurances can be provided as to any result or the timing of any outcome regarding matters described herein or otherwise with respect to any regulatory action, administrative proceedings, government investigations, litigation, warning letters, consent decree, cost reductions, business strategies, earnings or revenue trends or future financial results. References to products and the consent decree are summaries only and should not be considered the specific terms of the decree or product clearance or literature. Unless legally required, the Company does not undertake to update or revise any forward-looking statements even if events make clear that any projected results, express or implied, will not be realized. Other potential risks and uncertainties that could cause actual results 31



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to differ materially from those in the forward-looking statements include, without limitation, (a) the potential for increased pressure on pricing or costs that leads to erosion of profit margins, (b) the possibility that market demand will not develop for new technologies, products or applications or services, or business initiatives will take longer, cost more or produce lower benefits than anticipated, (c) the possibility that application of or compliance with laws, court rulings, certifications, regulations, regulatory actions, including without limitation those relating to FDA warning notices or letters, government investigations, the outcome of any pending FDA requests, inspections or submissions, or other requirements or standards may delay, limit or prevent new product introductions, affect the production and marketing of existing products or services or otherwise affect Company performance, results, prospects or value, (d) the potential of international unrest, economic downturn or effects of currencies, tax assessments, adjustments or anticipated rates, raw material costs or availability, benefit or retirement plan costs, or other regulatory compliance costs, (e) the possibility of reduced demand, or reductions in the rate of growth in demand, for the Company's products and services, (f) the possibility that anticipated growth, cost savings, new product acceptance, performance or approvals, or other results may not be achieved, or that transition, labor, competition, timing, execution, regulatory, governmental, or other issues or risks associated with our business, industry or initiatives including, without limitation, the consent decree or those matters described in our Form 10-K for the year ended March 31, 2014 and other securities filings, may adversely impact Company performance, results, prospects or value, (g) the possibility that anticipated financial results or benefits of recent acquisitions, or of our restructuring efforts will not be realized or will be other than anticipated, (h) the effects of the contractions in credit availability, as well as the ability of our Customers and suppliers to adequately access the credit markets when needed, and (i) those risks described in our Annual Report on Form 10-K for the year ended March 31, 2014, and other securities filings.



Availability of Securities and Exchange Commission Filings

We make available free of charge on or through our website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to these reports as soon as reasonably practicable after we file such material with, or furnish such material to, the Securities Exchange Commission ("SEC.") You may access these documents on the Investor Relations page of our website at http://www.steris-ir.com. The information on our website is not incorporated by reference into this report. You may also obtain copies of these documents by visiting the SEC'sPublic Reference Room at 100 F Street, NE, Washington, D.C. 20549, or by accessing the SEC's website at http://www.sec.gov. You may obtain information on the Public Reference Room by calling the SEC at 1-800-SEC-0330.


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