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Edited Transcript of STE earnings conference call or presentation 7-Feb-17 3:00pm GMT

Thomson Reuters StreetEvents

Q3 2017 STERIS plc Earnings Call

Leicester Feb 7, 2017 (Thomson StreetEvents) -- Edited Transcript of Steris PLC earnings conference call or presentation Tuesday, February 7, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Julie Winter

STERIS plc - IR Director

* Walt Rosebrough

STERIS plc - President, CEO

* Mike Tokich

STERIS plc - SVP, CFO, Treasurer

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Conference Call Participants

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* Chris Cooley

Stephens Inc. - Analyst

* Larry Keusch

Raymond James & Associates, Inc. - Analyst

* Jason Rodgers

Great Lakes Review - Analyst

* Mitra Ramgopal

Sidoti & Company - Analyst

* Matt Mishan

KeyBanc Capital Markets - Analyst

* Joel Kaufman

Goldman Sachs - Analyst

* Dave Turkaly

JMP Securities - Analyst

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Presentation

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Operator [1]

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Welcome to the STERIS fiscal 2017 third-quarter conference call. (Operator Instructions). Today's call will be recorded for instant replay.

I'd like to introduce today's host, Ms. Julie Winter, Director of Investor Relations. Ma'am, you may again.

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Julie Winter, STERIS plc - IR Director [2]

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Thank you, Mae, and good morning everyone. On today's call, we have Walt Rosebrough, our President and CEO, and Mike Tokich, our Senior Vice President, CFO, and Treasurer, as usual joining us for this morning's call.

I do have a few words of caution before we open for comments from management. This webcast contains time sensitive information that is accurate only as of today. Any redistribution, retransmission, or rebroadcast of this call without the expressed written consent of STERIS is strictly prohibited.

Some of the statements made during this review are or may be considered forward-looking statements. Many important factors could cause actual results to differ materially from those in the forward-looking statements, including, without limitation, those risk factors described in STERIS plc's, STERIS Corporation, and Synergy's previous securities filings. Many of these important factors are outside of STERIS' control. No assurances can be provided as to any results or the timing of any outcome regarding matters described in this webcast or otherwise. The Company does not undertake to update or revise any forward-looking statements as a result of new information or future events or developments. STERIS plc and STERIS Corporation SEC filings are available through the Company and on our website.

Adjusted earnings per share per diluted share, segment operating income, constant currency, organic growth and free cash flow are non-GAAP measures that may be used from time to time during this call and should not be considered replacements for GAAP results. Non-GAAP financial measures are presented during this call 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.

STERIS's adjusted earnings per diluted share and segment operating income exclude the amortization of intangible assets acquired in business combinations, acquisition related transaction costs, integration costs related to acquisitions, and certain other unusual or nonrecurring items. We define free cash flow as cash flows from operating activities less purchases a property, plant, equipment and intangibles, net capital expenditures, plus proceeds from the sale of property, plant, equipment, and intangibles. Additional information regarding adjusted earnings per diluted share, segment operating income and free cash flow is available in today's release.

With those cautions, I will hand the call over to Walt.

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Walt Rosebrough, STERIS plc - President, CEO [3]

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Thank you Julie and good morning.

Fiscal 2017 has been a year of transition for STERIS with substantial success along the way. Following the close of the combination with Synergy Health, we made decisions about actions we wanted to take to improve the new STERIS. Some of those have been apparent to all of you and some are happening quietly behind the scenes as we continue to work to be more efficient, deploy new systems, and maximize the opportunities of the combined businesses.

We've had success on several broad objectives, first integrating the companies and achieving the $30 million to $40 million in cost synergies that we expected. I'm happy to report that most of the integration effort has gone smoothly and, by the end of this fiscal year, we will have achieved about $25 million in aggregate cost savings, or about $5 million ahead of our schedule. This isn't simply a pull forward. Rather, we believe that the aggregate savings we will achieve are at least $45 million in annual cost savings by the end of fiscal year 2019 with the balance divided about evenly across the next two fiscal years.

A second major objective has been to divest the legacy Synergy linen businesses which do not fit our business strategy but consume valuable management focus and capital and dilute profit margins. As you know, we sold the UK linen business early this year and we completed the disposition of the US linen business just after last quarter's earnings call. We expect to complete the final transaction to completely exit the remaining linen business in the very near future.

Improving overall operating margins was also an objective, and I'm pleased about our year-to-date 140 basis point improvement in operating margins on a Company-wide basis, even with lower than expected revenue. This is a direct result of general cost improvement, cost synergies of the combination, and divestiture of lower margin businesses. We anticipate continued improvement in the fourth quarter.

While the divestitures we have completed reduced the rate of repair the reported revenue increase in the short term, we are not giving up much in terms of operating profit. Indeed, by the end of the fiscal year, we target completion of divestitures that reduce annualized revenue by approximately $280 million but annualized earnings per diluted share of only about $0.10. We have already completed acquisitions this fiscal year that will offset an estimated $0.08 of the decline in annualized earnings per share but add only $30 million of annualized revenue. Obviously, this improves operating margins, and it also reduces capital demands with only about a $0.02 net reduction in annualized EPS.

Finally, we have had success increasing our cash flow and reducing our debt. We do not believe that the current historic low interest rates will last forever, so we have also fixed the interest rates on a larger portion of our debt and intend to pay off more of the floating-rate debt as we reduce our overall leverage. We believe that the cash we are generating, along with our strong balance sheet, will give us considerable flexibility to promote shareholder value through funding our organic growth and acquisitions, reducing our leverage and being able to continue to return cash to shareholders.

Turning now to the results of our operations so far this year, looking at our segments on a year-to-date, constant currency, organic revenue basis, all four segments have delivered low to mid single-digit revenue growth even though capital equipment shipments have been flat in both Healthcare Products and Life Sciences. While we have shifted our revenue base more towards recurring revenue, we're not completely immune to market timing fluctuations, including the timing of holiday shutdowns and inventory management by our customers. We believe both of these factors negatively impacted our performance in the third quarter more than normal in our consumable franchises as well as in the AST segment. We were about on forecast with these businesses in the quarter until the month of December when our recurring revenues became softer than we expected. Our consumables and AST revenues in January suggest this was timing as we appear to be back on our planned run rate levels.

Although we had solid constant currency revenue growth across our segments in general, clearly we had pockets of the business we anticipated would be stronger this year. I will spend some time on those before moving on to our outlook.

As we've discussed in prior quarters, we have seen a shift towards large project orders for capital equipment in our Healthcare Products segment, which has increased our backlog compare the prior years, especially in the first half of this fiscal year. This shifted our shipment patterns somewhat from quick term replacement orders to longer lead time project orders, which had the effect of reducing shipments and increasing backlog on a relative basis. That pattern reversed somewhat in the third quarter as we shipped a number of the large projects that were in backlog and saw replacement type orders return to normal levels.

We've also experienced continued strength in our North American capital equipment business offset weakness in most of OUS markets. The rest of the healthcare product business is having a good year in total with consumable revenue growth of 7% and service revenue growth of 4% on a constant currency organic basis.

We plan on a stronger growth in our Healthcare Specialty service segment from both a top and bottom line perspective this year. There are several issues at play here. As we have discussed all year, our IMS business got off to a slower start than anticipated and our cost structure a bit upside down, having hired both field and infrastructure personnel in anticipation of stronger growth than has occurred this year. The loss of business that we experienced early in the fiscal year has impacted our ability to grow above market until we anniversary that loss early in fiscal 2018.

We have been successful at winning new business, which has allowed us to maintain mid-single-digit revenue growth in line with the overall healthcare market. In addition, we believe we have bottomed out our profitability decline as our growth is catching up with our spending and are beginning to turn upward. We expect to exit fiscal year 2018 at a high single-digit operating margins run rate.

We also experienced under-performance in parts of the legacy Synergy business in this segment, primarily from three areas: the linen business globally; the outsourced processing business for SterilMed; and the US outsourced instrument processing business. As we've already discussed, we have successfully exited two of the linen businesses and expect to exit the final month this year. We've also worked with SterilMed to improve the profitability of that unit going forward, and we've integrated the legacy US Synergy and STERIS IMS instrument processing business. As a result, we anticipate improved profitability going forward even as we continue to invest in the nascent CSD outsourcing opportunity in the United States.

I will emphasize that the legacy Synergy outsourced CSD business in Europe is meeting our performance expectations on a constant currency basis, that it is soft as reported due to the weaker euro and pound when translated to dollars.

The AST segment continues to grow revenue nicely on a constant currency organic basis, and we are making good progress on our expansion plans. We expect that some of the capital expenditures we thought we would spend this year in this segment will fall into fiscal 2018 and we've adjusted our outlook for CapEx as a result. This is simply the timing of construction expenses as we have seen modest delays in our expected timelines with our facility expansions in New York, California, and Europe. We continue to believe the intermediate to long-term results of the Synergy-STERIS-AST combination will exceed our original expectations on a constant currency basis, but, once again, the weaker euro and pound have had a negative impact on European business as reported in dollars.

We are also continuing above-market growth in the Life Sciences segment with double-digit constant currency organic revenue growth in consumables in both our formulated chemistries business as well as our barrier protection products.

On the service side, we have new offerings enhancing our performance issues with underlying growth in the low single digits. As you know, the capital equipment revenue in Life Science is lumpy and our first three quarters reflect that. Our growth was very strong in Q1, solid in Q2, and we retracted significantly in Q3. We are expecting a strong Q4 to finish the year, and our increased backlog supports that view.

From an overall profitability perspective, the operating margin for Synergy improvement we generated in the third quarter demonstrates the success we are seeing in implementing our strategies. On a year-to-date basis, our operating margins as a percent of revenues have improved 140 basis points to 17.5%. We anticipate higher profitability in the fourth quarter.

There is no doubt that our businesses are broader in product scope and international exposure than they were just a few years ago. We have substantially improved opportunities by utilizing our strong balance sheet and cash flow to invest for growth, both internally and through acquisitions. We are a more global business and, as such, foreign currency exchange movements have a greater impact on our revenue. At the same time, we have a more balanced global portfolio, which helps to mitigate currency impact on the bottom line.

Our most recent quarter reflected the substantial puts and takes from acquisitions and investors as well as a $10 million currency headwind in revenue. That noise will increase in the fourth quarter as we expect $40 million in revenue reduction compared to the prior-year quarter strictly due to divestitures. We also expect to see a reduction in our as-reported revenue due to the impact of foreign currency with close to $20 million in headwinds in the fourth quarter alone. All of this will result in a decline in reported GAAP revenue even though constant currency organic revenue growth will be in the mid-single digits.

Given our performance year-to-date, we are taking a more conservative approach to our revenue outlook and reducing our full-year anticipated constant currency organic growth rate to 4% with revenue growth in all four of our segments. When we look at our total Company outlook of 17% growth, we have an additional headwind from currency of about $10 million compared with our last outlook. This will result in a total of approximately $35 million in revenue headwinds from currency for the full fiscal year.

Our full-year adjusted earnings per diluted share are now anticipated to be in the range of $3.70 to $3.76, reflecting the lower than anticipated performance in the third quarter and a somewhat higher effective tax rate of about 26% for the full year. As we've discussed in the past, our tax rate will fluctuate based on the geographic mix of our profit now that we are on a regional tax system. Our US business has continued to outperform our business in the rest of the world, particularly when the impact of currency is included. And as you know, the US currently has the highest tax rate in the world.

In terms of next year, I want to remind you again that we have completed a number of divestitures over the course of this year and we are working to complete a couple more if we can come to agreement on appropriate terms. If the divestitures occur in the time frame we anticipate, it will have negligible impact on reported profit versus our revised guidance for FY2017 and about a $15 million to $20 million reduction in reported revenue from our revised FY2017 revenue outlook. Assuming we are successful with these divestitures, we will have substantially completed our efforts to rationalize the business from the combination of STERIS and Synergy Health. Due to the timing of our acquisitions and divestitures, we would expect that revenue would be reduced by approximately $150 million in net impact in FY2018 with negligible impact to earnings on a year-over-year basis.

We recognize that these divestitures and acquisitions create noise in comparison to the previous year in our ongoing forward results. We are committed to transparency and have added increased disclosures in the press release tables to assist you in an analysis of these changes. We will continue to provide this analysis as we complete these deals going forward.

In closing, we are pleased with the progress we have made this year even though we are disappointed to be below our original revenue and profit expectations. The integration of the businesses, the divestiture of those that do not fit our strategy, significant refinancing to lock in low interest rates combined with the complexities of Brexit currency headwinds, difficulties in international markets, and potential changes in the healthcare and taxation landscape in the US have been a lot to digest. With all that, we are growing in line with market and better positioned for the long-term.

The core businesses of both STERIS and Synergy are strong and performing well. I think that's an important point. The core businesses of both STERIS and Synergy are strong and performing well. The divestitures we had made were below market growers and carried lower than average margins and in certain cases were operating at a loss. Those the versus years divestitures will help our growth and profitability profile going forward and allow management to concentrate on the businesses that fit our strategy.

The nascent opportunity of our HHS segment in the United States is still a work in progress, but we believe it will perform over time.

We appreciate the patience from our long-term investors who have seen us improve profit performance before as we improved our legacy Healthcare, Life Science and Isometic segments a few years ago. We fully intend to do it again.

We've created a company that is clearly in a leadership position in sterilization and disinfection and in the procedural areas of healthcare. We've balanced revenue across hospital and other procedural care center, pharmaceutical, and medical device customers. We are more balanced across capital equipment, consumables, and service. We are more global, and we are better focused on the growth areas of healthcare -- procedures, medical devices, vaccines, and biologics. We are poised to execute with this stronger portfolio and optimistic about what lies ahead. We thank all of you for your continued continuing support.

With that, I will turn the call over to Mike to review our third-quarter financials in more detail. Michael?

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Mike Tokich, STERIS plc - SVP, CFO, Treasurer [4]

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Thank you, Walt, and good morning, everyone. It is my pleasure to be with you this morning to review our third-quarter adjusted financial results.

Our third-quarter total revenue grew 5%. Growth was driven by 3% constant currency organic revenue growth plus the positive revenue contribution from acquisitions. Offsetting that growth was a 170 basis point headwind from currency, the largest impact we have seen this year. Organic revenue growth was entirely driven by volume, as price was unfavorable by 40 basis points in the quarter.

Gross margin as a percentage of revenue for the quarter increased by 80 basis points to 40.1%. Gross margin was favorably impacted by a 140 basis point improvement coming from the divestitures, 60 basis points due to foreign currency, 30 basis points from the suspension of the medical device excise tax, and 10 basis points from other items. As discussed in previous quarters, these favorable items were offset by 160 basis points due to the impact of the accounting policy changes we had made for the legacy Synergy Health business which will be fully anniversaried going forward.

We are pleased with our ability to continue to leverage revenue growth and expanding EBIT margins. EBIT margin at 19.4% of revenue represents a 200 basis point improvement as compared to the prior year. EBIT margin benefited from the impact of the positive contributors to gross margin as well as lower SG&A expenses as a percentage of revenue, including a favorable foreign currency impact of about $1 million.

The effective tax rate in the quarter was 26.6%, up substantially from the prior year as, last year, we benefited from favorable discrete item adjustments. The actual third-quarter effective tax rate is higher than our expectations due to a greater percentage of our income being earned in higher tax rate jurisdictions, primarily in the United States. We are now at 25% effective tax rate through the first nine months, but we do anticipate a continued income shift to higher tax rate jurisdictions to occur in the fourth quarter.

Net income in the quarter increased 10% to $84 million. Taking into consideration the higher share count versus last year, earnings per diluted share were flat at $0.98.

Moving on to the segment results, please note that my comments regarding revenue growth are all on a constant currency organic basis, all of which you can find in our press release tables. Healthcare Products segment revenue grew 4% in the quarter driven by growth across the business. Service revenue increased 5%. Capital Equipment revenue grew 4%, and Consumable revenue group 3%. Within Capital Equipment, we saw strength in our OR integration offering and washers during the quarter. Reflecting continued strength in new orders, backlog in Healthcare Products increased 4% to $150 million in the quarter and was led by growth in infection prevention products.

Healthcare Products operating income increased 25% and operating margins improved 370 basis points to a record 20.2% of revenue in the quarter. The margin increase is due primarily to operational efficiencies, favorable foreign currency, the suspension of the medical device excise tax, and the positive impact of both acquisitions and divestitures.

Revenue for Healthcare Specialty Services increased 3% in the quarter, reflecting 4% revenue growth in IMS and mid-teens revenue growth from the legacy Synergy CSD outsourcing business in Europe. This growth was offset by lower growth coming from legacy Synergy linen and SterilMed businesses.

Healthcare Specialty Services margin for the quarter were at 1.7%, a decrease from the prior year due to the declines within the legacy Synergy linen and SterilMed businesses as well as lower than anticipated performance in IMS offset by favorable margin improvement from divestitures.

Applied Sterilization Technologies had a good quarter, growing revenue 6% with strength across all geographies. Applied Sterilization Technologies' operating margin increased to 33.1% of revenue due primarily to the increase in volume and cost savings from the combination with Synergy.

Life Sciences revenue for the quarter declined 6% as consumable revenue grew 5% and service revenue grew 2%. This growth in consumable and service revenue was more than offset by the lumpy capital equipment shipments, which were down 27% in the quarter. Backlog in Life Sciences ended the quarter at $47 million, up 4%.

Despite the decline in revenue, Life Sciences' third-quarter operating margin improved 140 basis points to 30.6% of revenue in part due to favorable product mix and disciplined expense control.

In terms of the balance sheet, we ended the quarter with $264.9 million of cash, approximately $1.5 billion in total debt, and a debt to EBITDA leverage ratio of approximately 2.5 times. We recently announced the signing of a new multi-currency private placement agreement totaling approximately $296 million. The new private placement notes will fund on February 27 and the proceeds will be used to repay floating-rate bank debt, thereby increasing the Company's portion of fixed rate debt. The new notes will have a weighted average maturity of about 11.8 years with a weighted average interest rate of approximately 3%. This transaction by no means impacts our expectations of reducing our debt to EBITDA leverage ratio to be more consistent with historic levels.

With the anniversary of the combination with Synergy, our DSO is now normalized. DSO at quarter end was 59 days, consistent with historic levels.

Free cash flow for the first nine months was $182 million, a substantial increase versus last year, primarily due to higher net income and a reduction in acquisition related expenses. Included in year-to-date free cash flow is about $11 million of cash expenses related to the integration of acquisitions.

During the quarter, we repurchased about $30 million in stock at an average price of $68.18. In total, we have repurchased approximately $88 million of stock to offset dilution, acquiring just over 1.2 million shares this fiscal year.

Capital spending was $38.4 million in the quarter while depreciation and amortization was $31.4 million. Depreciation and amortization expense in the quarter was approximately $20 million lower due to the cumulative impact of the finalization of the purchase price allocation adjustment for the Synergy Health transaction.

Also during the quarter, we recorded an impairment charge of $58.4 million as we completed our annual goodwill impairment assessment, which concluded that the carrying value of the linen management business exceeded its fair value. The impairment charge is excluded from our adjusted financial results.

With that, I will turn the call back over to Julie to open it up to Q&A. Julie?

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Julie Winter, STERIS plc - IR Director [5]

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Thank you, Walt and Mike, for your comments. Mae, would you please give the instructions and we'll get started with Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions). Chris Cooley, Stephens.

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Chris Cooley, Stephens Inc. - Analyst [2]

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Thank you. Good morning. I appreciate your taking the questions. I appreciate your prepared commentary this morning, and congratulations. You guys have done a Herculean effort here, basically taking a lot of costs out of the model, getting much better leverage, and integrating the new Synergy transaction in a difficult environment -- all to be commended.

Could you help us, maybe to start, maybe other better understand some of the vagaries that you are having to deal with in terms of just looking at the consumable portion of your business? Clearly, there was some variability there versus I think Street expectations. And just maybe better help us understand what you saw during I guess November, December, and now obviously improving in it sounds like here in the first part of calendar 2018. Just help us better understand maybe some of the backdrop there and how you address that. And I've got a couple of quick follow-ups.

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Walt Rosebrough, STERIS plc - President, CEO [3]

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Yes, Chris, you are absolutely correct. Our -- and I would say it's not just consumables. Our recurring revenue businesses all were below our expectations in the back have of December, basically even in the beginning of December looked kind of normal. The back half of December was very weak. And so when I say recurring, I'm including the consumables on both Healthcare, Life Science, and the AST business.

We did see a number of things. We did see more of our customers on the Life Science and medical device side taking a bit longer shutdowns in some of their plants, which is typical in the Christmas time, both for maintenance and for holiday, so we saw more of that than we are accustomed to. And then we just saw some weekend orders, if you will, orders and shipments, because those tend to be fast turnaround shipments in both Healthcare and the Life Science space in the month of December. November was actually quite strong, just the opposite, so I'll skip the November conversation, because everything I'm saying about December is exactly the opposite of November. November was quite strong. So, we were basically on our forecast at the end of November and then we just saw a slowdown across the Board, across all segments of business on the recurring revenue side, consumables and recurring revenue. Now, we have seen -- now we're in the fifth week of the calendar year, and we have seen all of those come back to normal levels, so we are encouraged that one of two things has occurred. Either it was a one-time adjustment in the inventories of our distributors, our customers, or the manufacturers of the medical devices, or it was just a timing question and they're actually going to bring back that revenue over the next couple of months. We are taking I would characterize it as the more conservative you that we are using -- we have placed our consumables and recurring revenue, AST and Life Science and Healthcare Consumables on our planned rates, the rate we expect to see. If there is a bounce back, there is some plus to that. But we think, given that we don't know for sure the answer to that question, taking the conservative view that it was a one-time I'll call it inventory adjustment is the better approach.

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Chris Cooley, Stephens Inc. - Analyst [4]

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Understood. And then maybe just two quick follow-ups for me and then I'll get back in queue. I guess continuing to kind of press on the top line a bit, unfortunately, this is the third consecutive quarter -- and I realize you give annual guidance -- but the third consecutive quarter where there's been some softness versus Street expectations. And again, I fully appreciate the number of moving parts that are associated with this. But is there anything new that the Synergy acquisition has presented, or is there a need internally to maybe alter the way you look at forecasting going forward such that maybe greater visibility into kind of what those top line growth rates may or may not be? Because we are really looking at about a 30% reduction here at 4%, which is still healthy but not quite I think what the Street was assuming from the combined entity of STERIS and Synergy. And again, I fully understand there's been a number of divestitures and FX headwinds.

And I guess the other part of it is, just when we think about the tax rate, I fully appreciate again there that the US is also the highest effective tax rate, in the US. But how do we think about tax policy going forward in this - that 25-ish% bogey that you guys had out there originally? Is that -- should we still be thinking about that longer-term, or should we be thinking about rates creeping up more towards the upper 20s%, 30% rate? Thanks so much.

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Walt Rosebrough, STERIS plc - President, CEO [5]

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Sure, Chris. I'll take those questions in sequence and then ask if Mike has any more comment on the tax. But it is obvious that we were overly bullish at the first of the year in terms of our growth rate, and that's just full-stop. We were overly bullish. So the Street's expectations were set by us. We made an error there, and we are clearly moving to a more conservative view. So I would guess that's the short answer.

In terms of the fundamental businesses, and particularly the core businesses, we don't feel any differently about those as we have in the past, and we also don't feel any differently about the fundamental growth rates of the business. We like the positions we're in. We like the markets we're in. We like those spaces, and we believe those to be slightly better than I'll call it the general market for healthcare because we like the procedural space, the device space, which really follows procedures, and the pharma space that we happen to be in. So we think we had have solid market type growth rates ahead of us. We anticipate picking up a little bit more through a combination of product development and acquisition, and we expect our bottom line to still be in the double-digit range. So we don't feel any differently about our long-term.

And I will say even though we're not having the year we had hoped to have, we're still going to be at double-digit profitability kind of growth rates and market or above-market revenue growth rates.

So our biggest relative issue is we've agreed that were more bullish than it turned out we are going to be this year. But if you look at our long-term history and how this reflects on our long-term history, we don't feel any differently about the core Synergy businesses, the AST business and the HHS business in Europe, the core STERIS businesses, the Healthcare Products business, the Life Science business and the AST business. So, those we feel strongly about.

The HHS business, we have -- in the US now, the HHS US business we have felt would be a longer-term nascent business that we could grow. And clearly, the IMS business, we get this revenue surprise which also created a profit surprise. But again the long-term perspective of that business we still see as positive, above market growth rates, and we believe we can bring that back to the kind of profitability we talked about, the high single-digit kind of profitability, low double-digit, over a longer time. So, at the highest level, we don't feel differently about the business.

Now, there were some pieces of the business at Synergy that, when we acquired it, we weren't 100% sure what we were going to do or not going to do, particularly the lending business; we talked about that at great lengths. Synergy was not considering that a core part of their business. They were quite open about that. We felt exactly the same way. As we looked at it, we felt even more strongly I suppose. And those businesses have not performed all that well, below our expectation, clearly. And so exiting those we see is the right thing to do. I think that answers the first question.

The second, in terms of tax rate, we are going to have more variability in tax rate because we've moved from a global system to a regional system. And global system, it used to be pretty easy because, whatever the US tax rate was, that was our tax rate minus some discrete item adjustments or some opportunities that we had because of acquisitions. But generally speaking, it was the US tax rate. Now it is the blended rates of those various countries.

Again, to be clear, the general reduction in tax, which is a fixed number reduction as a result of doing the Synergy acquisition, we have seen that and we continue to see that reduction on a dollar basis, so there has been no change in that. It is the variable component. The variable component is what tax rates or what countries you make profitability in and what the resulting tax rates are.

In general, we see a movement toward lower tax rates around the globe. Again, that's the conversations among politicians today. How that will specifically work out, we're not clear, but we don't see a reason to think that we would be out of that mid-level tax rate at the current income tax regimes that we have in place. Now, there's a lot of things being talked about and I think it's way too early to try and forecast what -- first, you have to know what they intend to do and then you have to know how they intend to transition to that spot, or those spots, and it's too early for us to comment on that. But in the current tax regimes, we feel that that 25-ish% is the right place, mid-20s is the right place, not back to the 30% rate. And the bulk of the differential there is the reduction of our sold business outside the US. Again, we have been strong inside the US and weaker outside the US. That's been the long-term trend for us and the market. And then, secondly, the translation of the Synergy business in OUS, which has been quite strong, both in AST and HHS, but when you translate it in parentheses, it had fallen 30% -- it translates to a much smaller number, so the taxes are impacted, as you would expect. I don't know, Mike, if you have any other comment there?

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Mike Tokich, STERIS plc - SVP, CFO, Treasurer [6]

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I would just agree with you that we are achieving the full benefits from the Synergy Health combination as well, as outlined. I'd just like to add that we have and we will continue to focus on additional tax planning strategies and opportunities as we go forward. As Walt said, there is some uncertainty, and that does cause us a little bit of delay in some of those tax planning strategies. But overall, I agree with Walt. The mid-20s% is about where we expect to be.

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Chris Cooley, Stephens Inc. - Analyst [7]

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Thanks so much. I appreciate all the color.

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Operator [8]

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Larry Keusch, Raymond James.

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Larry Keusch, Raymond James & Associates, Inc. - Analyst [9]

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Hi. Good morning. So, Walt, I want to just pick up a little bit on the top line growth rates. You started out the year with sort of legacy STERIS organic growth of 7%. We've kind of walked down now for the entire Company now that you've got Synergy in the organic growth rate two months this quarter and the full fourth quarter to about 4%. So I guess, just in broadbrush strokes or high-level, how do you think about the longer-term growth of the business given the markets that you're in? Is it right to think about this perhaps as more of a 4% to 5% grower and really not think about it as a 6% or a 6% plus grower going forward?

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Walt Rosebrough, STERIS plc - President, CEO [10]

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You know, Larry, I think we haven't changed our long-term view even during this process, even though we had a short term variation. But the long-term view we have and have had and continue to have is that we have -- we're in a market that generally is a mid-single-digit kind of growth market. That's called healthcare in general. And we're pretty broadly across healthcare. But we tend to be focused more in some of the more rapidly growing areas. And I believe that could give us 0.5 point or 1 point. And then we intend to do things to grow a little faster than that. So we still view this business -- our targets or our objectives, and we think they are reasonable objectives, is to be in that mid to upper, if you will, single-digit growth rate. Something in that 5% to 7% range kind of numbers is what we have said and continue to believe. And then if we do some acquisition, that gets us more into that 7%, 8% acquisition or overall growth rates and that we should grow our profitability faster, so that gets us to double digits. And we have not wavered from that. There were people that viewed that Synergy would change that trajectory. We have never said that. We run a larger business now and we believe we can continue that trajectory that we have set for a number of years and we intend to continue to do so. We don't see a variance from that in the long term. Now, we were more bullish in the short-term period, no question, and that has not turned out to be the case, but we don't see that being a reflection of the long-term position of the business. And as we've refocused on the businesses that we view are strategic businesses, we feel more strongly about it.

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Larry Keusch, Raymond James & Associates, Inc. - Analyst [11]

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Okay. Great. That's helpful color. Two other questions for you. I guess the other sort of longer-term view question is I think you've generally targeted sort of 50 to 100 basis points of operating margin expansion on an annual basis, again, just through all of the initiatives that you guys have been putting into place. And that would be on top of synergies certainly coming out of the Synergy acquisition. Again, are there still, despite all the positive moves you've made this year, are there still opportunities to drive profitability higher in kind of the 50 to 100 basis point of operating margin expansion still the right way to think about it?

And then the other question, I'll just ask it, is there any way that you can help us bridge the revised 2017 EPS guidance from the prior $3.85 to $4.00 number in helping us think about what FX did there, what the higher tax rate did, any of the changes in timing, the more conservative outlook that you've taken here with be helpful.

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Walt Rosebrough, STERIS plc - President, CEO [12]

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Yes, I'll get the two questions separated. First is, on operating efficiencies, Larry, as you know, I tend to not describe operating efficiencies in percentages but in dollars first. We go after dollars, and that happens to result in percentages. We go after dollars and we absolutely do not believe we have come to the bottom of the well of improvement opportunities. We think we have significant improvement opportunities going forward.

Secondly, as we achieve those opportunities, we do not always take them all to the bottom line. Sometimes we put them back in holding prices. And as a result, we think that makes us stronger in terms of our ability to hold or gain share. So we do not put all those efficiencies in the bottom line.

But you are correct. We have a habit, generally speaking, if you put all that together either by growing revenue and having a relatively fixed base of cost or by bringing those variable efficiencies to the bottom line or some portion of them, we have tended to raise profitability. And we have units that clearly need more work there and we have units that are doing very nicely there. But we expect all of them to work to improve their efficiency and we don't think we are anywhere near.

And I would add a couple of things there. I guess is first of all insourcing and on-shoring is becoming an interesting fad these days. It's a fad that we started doing seven or eight years ago. We fully intend to continue to do that. And so -- and we believe we have gained significant efficiencies in doing that, at the same time creating some nice employment in the United States. At the time we started this, we had 3,200, 3,300 people in the US. On a constant basis, without acquisition, we know we've grown 700 or 800 people, jobs, if you will, because we have insourced and on-shored those types of things.

And secondly, due to the acquisitions, we have about 7,000 people in the United States and we know that we have saved jobs in the US by doing that. It turns out that looks like a good thing to have done. We thought it was a good thing to do because it's good basic business, but we think it's a good thing to do.

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Mike Tokich, STERIS plc - SVP, CFO, Treasurer [13]

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And then, Larry, on the reconciliation to help you -- EPS versus our prior outlook, it's actually two components. About a third of that reconciliation is due to the higher tax rate, and then about two-thirds is really due to the underperformance that we're ending Q3 that, as Walt talked about, we do not believe we will make that up in the full year although we will have a good fourth quarter but not good enough to make up that shortfall. So that's the two components to help you with the reconciliation.

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Larry Keusch, Raymond James & Associates, Inc. - Analyst [14]

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Okay. Great. Thank you very much, guys.

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Operator [15]

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Jason Rodgers, Great Lakes Review.

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Jason Rodgers, Great Lakes Review - Analyst [16]

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Yes. I wonder if you could talk a little bit more about the IMS business, why that has underperformed versus your expectations in the quarter and your plans going forward for that business.

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Walt Rosebrough, STERIS plc - President, CEO [17]

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Sure. Well, we've talked about it over the course of the year, but it has not picked up as much as we would have hoped. That is we lost some significant amount of business early in the year. Basically, there was a contract, a dual contract, with one of our larger customers and that contract changed. We still have a dual contract, so we still do business with that customer, but a more significant portion of it -- when it was first done, we thought it would be a significant loss. This was last fiscal year. It turned out not to be the case, so we did better than we expected last fiscal year. And then we expected significant growth this year on top of that.

What happened is we lost business. We've still grown but the net effect of that has been about a 4% constant currency growth rate. That would be fine if we hadn't thought it was going to be 10%. That's not the right, exact number, but it's close to the right, exact number. And so we thought it was going to be more like double digits, so we invested ahead of that, which you need to do in service because you have to train people to get things up to speed. You can't take business if you can't perform it in a service business. And so we had beefed up our costs in order to be able to perform that double-digit growth increase, and we have not seen it. We believe that business has continued to grow. We believe it will continue to grow, so we don't want to turn around and lay off people who we will need in our future after we've spent money and time and effort training them putting and them into place. So we're keeping that infrastructure in place and we will grow our way back to the levels of profitability we expect. At a high level, that's the conversation. It has taken us longer than we expected, and we've said that we expect the outgoing rate to get back to kind of more normalized levels at the end of next year. Our original thinking was it would be more like the end of this year or first part of next year, so it has taken longer than we expected but we fully intend to do it.

And in terms of the future, we like the business. We think it is a good business. We think it fits very nicely strategically with the Synergy HSS business, and we intend to move both of them across the pond. That is more of the IMS business over to the European areas and more of the HSS business to the US. We think that is a long-term good thing to do. It's just going to take time.

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Jason Rodgers, Great Lakes Review - Analyst [18]

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Back in November, you talked about some improvement in hospital spending internationally. Is that still the case?

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Walt Rosebrough, STERIS plc - President, CEO [19]

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Yes. I wouldn't characterize it as a whole lot different. Still the improvement is from a not such good level is the short answer. But we have seen Europe -- Europe specifically has not -- or has kind of held study. Now, EMEA, the Middle East has still continued to be very difficult, so big drops there, but we seem to have kind of bottomed out. Latin America, again, we seem to have kind of bottomed out. We haven't seen big increases but the falling has seemed to stop. And then our specific business actually seems to be picking up. So, we do feel a bit better about it in that it's not continuing to fall, but the currencies have continued to slide, which, when the euro and the pound fall 10% versus the US dollar, it makes it more difficult to sell that product overseas. And even when you do sell, it is at a lower price and lower profit typically. So that has -- the actual business environments in those nations I think have improved but the currency issues make it harder.

When we talk about the effect of currency on profitability, the piece that doesn't get picked up in I'll call it the accounting ledger is the business you don't get anymore because your prices and your costs and prices have gone up. So it's still -- currency has clearly put pressure on our OUS business.

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Jason Rodgers, Great Lakes Review - Analyst [20]

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And then just a few housekeeping items. With the new notes, what percent of your debt overall is fixed? And what is the new CapEx number that you have for fiscal 2017?

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Mike Tokich, STERIS plc - SVP, CFO, Treasurer [21]

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Jason, for a breakout between fixed and floating, we are moving from -- and I'm going to do this on a pro forma basis as if the funding would have occurred at the end of December. At the end of December, we were at a 44% fixed, 56% floating. With the new multicurrency private placement funding, that will move us to 63% fixed and 37% floating.

And then, from a capital expenditure standpoint, we have lower that lowered that a little bit. We are thinking it's now more in the $170 million range versus the $190 million range, and the bulk of that is what Walt talked about. Our AST projects have just slowed down a little bit. We ran into some issues, and that is just going to move into next year. We will spend it. It's just going to cross fiscal years.

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Walt Rosebrough, STERIS plc - President, CEO [22]

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But the issues are not I would call significant operational issues. They are getting licenses and getting permits. I'll call it the not so unusual things that happen when you are trying to bring new facilities or expand facilities. So, it's normal. It's modest timing change, not anything significant.

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Mike Tokich, STERIS plc - SVP, CFO, Treasurer [23]

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Normal construction delays.

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Jason Rodgers, Great Lakes Review - Analyst [24]

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Okay. Thank you very much.

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Operator [25]

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Mitra Ramgopal, Sidoti.

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Mitra Ramgopal, Sidoti & Company - Analyst [26]

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Hi. Good morning. Just a couple of questions. Walt, if you could talk to the mix you are seeing in terms of the large project orders versus the replacement? And based on the new administration in Washington, are you getting a sense from customers in terms of capital spending, if they are taking a wait-and-see approach in terms of healthcare reform, or is it still no change from your standpoint?

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Walt Rosebrough, STERIS plc - President, CEO [27]

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Sure. The mix question of large projects versus replacement is an ongoing, moving target. And we think of our traditional mix of roughly-two thirds replacement and one-third project, but it runs as high as 70% or 75% replacement at times and as low as 50%, 60% at some times. 50s% would be a low number but 60% would be not unusual. And it just -- replacement numbers tend to be lumpy -- excuse me, project orders tend to be lumpy and replacement orders tend not to be, so there is some movement in that. But we had seen a fairly strong temporal trend toward project the last nine to 12 months. This quarter happened to be balanced at almost exactly our rates. Our incoming orders were one-third/two-thirds almost on the number so -- and since we shipped some large projects and those came in, we've moved back toward a higher, a more normalized level of replacement orders. Those tend to ship more quickly, which is one of the reasons we feel the fourth quarter will be stronger.

And then, in terms of the go-forward question on CapEx, all of our leading indicators look steady, so we have not, at this time, seen any significant "wait and see", but there's a lot of turmoil in Washington these days. We will see how that turmoil works out. But at this point in time, our leading indicators do not suggest a pullback.

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Mitra Ramgopal, Sidoti & Company - Analyst [28]

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Thanks. And then quickly on the divestitures, I know you said there's one piece of the linen business left and then maybe a couple more you might be looking to do this year. Do you think, as we finish out 2017, divestitures and sort of being with the businesses you want to keep should be behind you and maybe you might start looking at some tuck-ins going forward? Or -- also the use of cash, is it going to be more towards you doing some share buybacks, early debt reduction as a priority, essentially raising the dividend? If you can give us a sense of how you are thinking in terms of the cash you are generating in deployment?

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Walt Rosebrough, STERIS plc - President, CEO [29]

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Sure. On the first question, I hope I was clear. I think, if what we think is going to happen this quarter happens, we will be finished with the -- there's always going to be some little divestiture here or there, but with the work that we anticipated doing with Synergy, we should be finished with that. So, we would hope that's behind us and finished.

On the capital allocation, we do not have any change of view on capital allocation, and we don't intend to change our dividend policy, so that's first point. The second point is we fully intend to fund organic growth in the business because that is the safest and surest growth to continue to generate high ROICs.

The next piece, we look at tuck-in type acquisitions. We have continued to look and we've actually done some, even this past year while we were doing those other things. And then we continue to pay down debt until we get to what we consider are more normal levels. And then finally, if there is other significant potential cash available, we would consider buybacks. So that has been for some time now since we did the Synergy deal, that's been our approach and we haven't changed that view.

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Mitra Ramgopal, Sidoti & Company - Analyst [30]

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Thanks. And just to clarify, the one the divestiture remaining that you hope to finish soon, is that already factored into the revised guidance?

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Walt Rosebrough, STERIS plc - President, CEO [31]

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We mentioned that in the comments. And just to point out, if it occurs in this year, the revised revenue guidance will fall slightly, and we gave the numbers earlier.

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Mike Tokich, STERIS plc - SVP, CFO, Treasurer [32]

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$15 million to $20 million on the top line --

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Walt Rosebrough, STERIS plc - President, CEO [33]

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And then the bottom line should have no significant effect.

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Mitra Ramgopal, Sidoti & Company - Analyst [34]

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Okay. Thanks again.

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Operator [35]

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Matt Mishan, KeyBanc.

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Matt Mishan, KeyBanc Capital Markets - Analyst [36]

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Good morning and thank you for taking the questions and squeezing me in. Walt, I just want to make sure I fully understand what the organic growth expectation is for the fourth quarter. I think you did a really nice job of outlining what the divestiture composition was, what the FX composition was. But the organic growth, are you expecting that to kind of accelerate in the fourth quarter from where you've been? And I'm just trying to get a sense for -- and then why not be a little bit more conservative around North America healthcare capital equipment given customers can very easily delay orders out of the first quarter, given uncertainty?

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Walt Rosebrough, STERIS plc - President, CEO [37]

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By definition, it has to pickup little bit to get to the 4% growth rate, but it is just a little bit. And we think we are being conservative kind of across the board in terms of our views largely over the consumable things we talked about earlier, recurring revenue things we talked about earlier. We have not seen delays. You are correct. It could happen, but nothing in our current window suggests that we're going to see that. So at this point in time, we're holding with the forecast. It is essentially the forecast we expected for the year. Now it is clearly more -- we have more North America and less OUS, but, other than that, it's essentially the forecast that we expected. And the backlog is sitting there for the bulk of it to ship. We do not historically see cancellations in the backlog. It happens upon a rare, rare occasion. We do sometimes see push-outs, but cancellations are really unusual.

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Matt Mishan, KeyBanc Capital Markets - Analyst [38]

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And then on Healthcare Specialty Services, first, can you give us an update on where Northwell is at? And then second, could you -- I believe you said you feel like you can get that business to high single-digit operating margins by the end of FY2018. Could you give us a sense of how you get there and just kind of walk us there?

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Walt Rosebrough, STERIS plc - President, CEO [39]

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I was specifically talking out -- I'll call it the IMS piece of that business which we've -- where we've seen declines and we expect to get that IMS piece back to that high single-digit. The balance of that business we're changing significantly by exiting the linen business. But partially that will depend on the investments we continue to make or we make to work to grow that ASA business. So that one we're not doing a forecast per se.

Now, coming back to the Northwell question, Northwell has, as you know, has been delayed for building purposes. They continue to be delayed, and so that is not something we will see revenue on the near to intermediate term. I do not expect to see revenue in the next fiscal year for the Northwell.

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Operator [40]

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Larry Keusch, Raymond James.

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Larry Keusch, Raymond James & Associates, Inc. - Analyst [41]

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Just two quick ones. First, Walt, you certainly mentioned SterilMed and working to improve that. Could you just again review what's been going on there and what you are doing to improve that relationship and agreement? And then the other question is just, since you are using forward rates, what are the assumptions for the euro, peso, and Canadian dollar, and I guess pound?

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Walt Rosebrough, STERIS plc - President, CEO [42]

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Sure. I'll address the SterilMed question. We have been working with SterilMed. We are in essence a contract re-processor for the SterilMed business, and there have been a number of changes in that business as we have moved forward. And so we have worked with SterilMed to do a couple of things -- find ways to improve the cost structure of the business working together and sharing the results of those savings. So, we do expect see our profitability in that business improve significantly the next little bit. So that's the answer to the first question.

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Mike Tokich, STERIS plc - SVP, CFO, Treasurer [43]

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I'll give the rates. So, for the outlook for the quarter using December 31 forward-looking rates, we anticipate that all four of the major currencies that we track and follow and that impact us will have further declines. So we had the Canadian dollar at $0.74. We have the euro at $1.06. We have the peso at $0.047 and the pound at $1.24. So all four of those are continuing to slide versus where we were in the third quarter.

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Larry Keusch, Raymond James & Associates, Inc. - Analyst [44]

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Okay. Great. Thanks, Mike.

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Mike Tokich, STERIS plc - SVP, CFO, Treasurer [45]

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You're welcome.

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Operator [46]

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Joel Kaufman, Goldman Sachs.

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Joel Kaufman, Goldman Sachs - Analyst [47]

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Hi, guys. Thanks for the question. Could you maybe just parse out what's driving the continued strength we are seeing at AST and growth trends from your customers which suggest that the market growth rate there continues to be pretty robust? I'm just trying to figure out if there's any market share dynamics happening behind scenes?

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Walt Rosebrough, STERIS plc - President, CEO [48]

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I wouldn't characterize a significant market share change. We do think two things. We work to continue to convince some customers that they would be better served to outsource that work as opposed to do it themselves, and we have seen a little bit of that. We have seen growth in the space, just underlying growth in the space. And then we've also seen that we have continued to do a nicer job with the global manufacturers, which is one of the things we expected to see. So, I suspect that we are picking up some share in the global manufacturers vis-a-vis either their own or local manufacturers -- local processors. So, I think it's a little bit, but I wouldn't characterize any of those as 3 points of share. It's half points or quarter points collectively over time.

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Joel Kaufman, Goldman Sachs - Analyst [49]

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Great. Thanks. And then maybe one for Mike. Can you just help us think about the opportunity for continued free cash flow growth? Should we expect the growth to moderate as you comp in the Synergy Health synergies? And are there any opportunities to improve the working capital?

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Mike Tokich, STERIS plc - SVP, CFO, Treasurer [50]

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Yes, I would say that, with a full year of the combination with Synergy and STERIS, we are north of $300 million. Our goal would be at least to increase cash flow on a net income increase going forward. And then from a working capital standpoint, I think we still have some opportunity in both the receivables, the DSO collection side, and also in inventory. I think those would be the two opportunities we would continue to press going forward.

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Joel Kaufman, Goldman Sachs - Analyst [51]

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Great. Thank you.

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Walt Rosebrough, STERIS plc - President, CEO [52]

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I would say just as a follow-on, we have said almost since the time we purchased Synergy that AST appears to be stronger than we expected. We still feel the same way. It's being masked by the currency in Europe. So the legacy Synergy part of the AST business doesn't look as strong as it really is, but, on a constant currency basis, they are doing nicely, and we expect that to continue. And we expect the efficiencies to continue and probably be more than we are forecasting at this point in time.

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Operator [53]

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Dave Turkaly, JMP Securities.

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Dave Turkaly, JMP Securities - Analyst [54]

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Thanks. Just to kind of follow-up on some of the other questions on the competitive landscape, maybe even just specifically in the Healthcare, segment is there anything new that you are seeing there, any update that you can give in terms of that market growth or anything that's changed sort of from a competitive landscape?

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Walt Rosebrough, STERIS plc - President, CEO [55]

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No. We have good competitors across the board in all of our -- every space we compete in, there are solid competitors but we don't see I would call it a radical change across the broad spectrum or -- there's always some little thing going on. One of us has a new product and the other one follows with a new product later, those kinds of things. But I would call it a generalized set of competitors -- we have good solid competitors in all of our spaces, and we are a solid competitor in all of our spaces. And so I haven't seen what I would call a significant shift any place.

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Dave Turkaly, JMP Securities - Analyst [56]

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And then I know it's certainly not a large impact, but is there any way to quantify sort of the timing of the holiday shutdown or the inventory management by the customers, either on a percent or dollar basis, in this quarter?

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Walt Rosebrough, STERIS plc - President, CEO [57]

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No, I don't think we would do that. We know there were slowdowns. We know we slowed down. We know that there were shutdowns. We can't do a one-to-one correlation, and we know we're picking back up, so that's what we know, but to quantify that directly would be very difficult.

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Dave Turkaly, JMP Securities - Analyst [58]

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Okay. Thanks.

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Operator [59]

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I show no other questions at this time. I'll turn the call back for any closing remarks.

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Julie Winter, STERIS plc - IR Director [60]

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Thank you, everybody, for joining us this morning. We look forward to talking to you again next quarter.

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Operator [61]

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Thank you for participating. You may disconnect at this time.