Julie Winter - STERIS Plc Walter M. Rosebrough - STERIS Plc Michael J. Tokich - STERIS Plc.

Chris Cooley - Stephens, Inc. Lawrence Keusch - Raymond James & Associates, Inc. Jason A. Rodgers - Great Lakes Review Mitra Ramgopal - Sidoti & Co. LLC Matthew Mishan - KeyBanc Capital Markets, Inc. Joel Harrison Kaufman - Goldman Sachs & Co. David L. Turkaly - JMP Securities LLC.

Welcome to the STERIS Fiscal 2017 Third Quarter Conference Call. . Today's call will be recorded for instant replay. I'd now like to introduce today's host, Ms. Julie Winter, Director of Investor Relations. Ma'am, you may begin..

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's, and Synergy's previous securities filings. Many of these important factors are outside of STERIS's 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 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 of property, plant, equipment, and intangibles, net capital expenditures, plus proceeds from the sale of plant 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..

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 continuing support. With that I will turn the call over to Mike to review our third quarter financials in more detail.

Michael?.

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 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 expand 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 grew 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 at 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 for Q&A.

Julie?.

Thank you, Walt and Mike, for your comments.

Mae, would you please give the instructions and we'll get started with Q&A?.

Thank you. Our first question is from Mr. Chris Cooley with Stephens. Your line is open..

Thank you. Good morning. And I appreciate you taking the questions.

Can you hear me okay?.

Yeah, Chris. Good morning..

Hey, good morning, Walt. 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 Synergy transaction in a difficult environment, all to be commended.

Could you just help us, maybe to start, maybe better understand some of the vagaries that you're 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 the calendar 2018. Just help us better understand maybe some of those, the backdrop there, and then how you addressed that? Then, I've got a couple of quick follow-ups..

Yes, Chris, you are absolutely correct. And I would say it's not just consumables. Our recurring revenue businesses all were below our expectations in the back half of December, and basically even in the beginning of December looked kind of normal. 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. What we did see, a number of things.

And 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're accustomed to.

And then, we just saw some weakened 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 our 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 inventories of our distributors, our customers, or the manufacturers of 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 view. 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..

Understood. And then maybe just two quick follow-ups from me, 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, 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're 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 then, I guess, the other part of it is, just when we think about the tax rate, fully appreciate again there that the U.S.

is also the highest effective tax rate, in the U.S, 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..

Sure, Chris. Let me – 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. And 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 than 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 the – 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 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 agreed that we 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 U.S. now. The HHS U.S. 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've 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 Linen business. We've talked about that at great lengths. I mean 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 as 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 U.S. tax rate was, that was our tax rate in a – minus some discrete item adjustments or some opportunities that we had because of acquisitions.

But generally speaking, it was the U.S. 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 their 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'll be out of that mid-level tax rates 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 to 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 U.S. Again, we have been strong inside the U.S. and weaker outside the U.S. That's been a long term trend for us and the market. And then secondly, the translation of the Synergy business in O-U.S., which has been quite strong, both in AST and HHS.

But when you translate it in currencies that had fallen 30%, it translated 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?.

Yeah. No, I would just agree with you that we are achieving the full benefits from the Synergy Health combination as Walt has outlined. 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 a delay in some of those tax planning strategies. But overall, I agree with Walt. The mid-20s% is about where we expect to be..

Thanks so much. Appreciate all the color..

Our next question is from Mr. Larry Keusch from Raymond James. Your line is now open..

Yeah. Hi, good morning..

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 for two months this quarter and the full fourth quarter – to about 4%.

So I guess just in broad brushstrokes or a 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 6%-plus grower going forward?.

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 that we tend to be focused more in some of the more rapidly growing areas. And I believe that could give us a half a point or a 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're reasonable objectives, is to be in that mid to upper if you will single digit growth rate. Something in that 4% to – or 5% to 7% range kind of numbers. That's 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 in 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've said that we'd run a larger business out. And then we believe we can continue that trajectory that we set – 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 this 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 business, we feel more strongly about it..

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 basis points to 100 basis points of operating margin expansion on an annual basis. Again just through all 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.

So again are there still – despite all the positive moves that you made this year, are there still opportunities to drive profitability higher? And kind of is that 50 basis point 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, is there any way that you can help us bridge the revised 2017 EPS guidance from the prior $3.85 to $4 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 would be helpful?.

Yeah. Get the two questions really separated. First is on operating efficiencies. Larry, as you know I tend to not describe operating efficiencies in percentages but in dollars first. And I don't – we go after dollars, so that happens to result in percentages. But 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, of you put all that together either by growing revenue and having a relatively fixed base 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're anywhere near.

And I would add a couple of things there. I guess is first of all, in-sourcing and on-shoring is becoming an interesting fad these days. It's a fad that we started doing seven years, 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 U.S. On a constant basis without acquisition we know we've grown 700 or 800 people, jobs if you will, because we have in-sourced and on-shored those types of things.

And secondly, through the acquisitions we now have about 7,000 people in the United States. And we know that we have saved jobs in the U.S. by doing that. 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 too..

Yeah. And then, Larry, on the reconciliation to help you versus – 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..

Okay, great. Thank you very much, guys..

You're welcome..

Next question is from Mr. Jason Rodgers with Great Lakes Review. Your line is open..

Yes.

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?.

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. And we – 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 there would be significant losses this last fiscal year. Turned out not to be the case. So we were – 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. Having 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 a like double-digits.

So we invested ahead of that, which you need to do in service, because you have to train people, 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 spent money and time and effort training them and putting them in 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 our 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 U.S. And we think that is a long-term good thing to do. It's just going to take time..

And back in November, you talked about some improvement in hospital spending internationally.

Is that still the case?.

Yeah. I wouldn't characterize it as a whole lot different and still the improvement is from a not such good level, is the short answer. But we have seen Europe specifically has not – or has kind of held steady. Now, EMEA, Middle East has still continued to be very difficult. And so big drops there, but we seem to have kind of bottomed out.

Latin America, again, we seem to have kind of bottom out. We haven't seen big increases, but we're – the falling has seemed to stop. And then our Pacific 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, and which – when the euro and the pound fall 10% versus the U.S. dollar, it makes it more difficult to sell that product overseas, and even what you do sell is at a lower price and lower profit typically.

So that has – the actual business environment in those nations I think have improved, but the currency issues make it harder. And 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 costs and prices have gone up.

So it's still – currency has clearly put pressure on our O-U.S. business..

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? Thank you..

Yeah, Jason. For 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 multi-currency private placement funding, that will move us to 63% fixed and 37% floating.

And then, from a capital expenditure standpoint, we have 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..

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

Normal construction delays..

Okay. Thank you very much..

You're welcome..

Our next question is from Mr. Mitra Ramgopal of Sidoti. Your line is open..

Yes. Hi. Good morning. Just a couple of questions.

Walt, if you could talk to the mix you're 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're taking a wait-and-see approach in terms of healthcare reform? Or is it still no change from your standpoint?.

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. 50% would be a low number, but 60% would be not unusual.

And 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 9 months 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.

And since we shipped some large projects and those came in, we've moved back toward 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 strong. And then in terms of the go-forward question on CapEx, all of our leading indicators look steady.

And 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..

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, the 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 is a priority, essentially keep raising the dividend? If you can just give us a sense of how you're thinking in terms of the cash you're generating in deployment?.

Sure. On the first question, I hope I was clear. I think if what we think is going to happen in this quarter happens, we will be finished with the – there's always going to be some little divesture 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. Again we don't tend to change our dividend policy. So that's the first point. The second point is we fully intend to fund organic growth in the business, because that's 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 intend to continue to pay down debt till we get to what we consider our more normal levels.

And then finally if there is other significant potential cash available, we would consider buyback. So that is our – that has been for some time now, since we did the Synergy deal, that's been our approach. And we haven't change that view..

Thanks.

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

Yeah. 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, $15 million to $20 million the top line, and then the bottom line should have no significant effect..

Okay. Thanks again..

You bet..

Next question is from Mr. Matt Mishan with KeyBanc. Your line is open..

Hey, good morning. And thank you for taking the questions and squeezing me in. Hey, Walt, I just want to make sure I – like 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 it.

And then why not be a little bit more conservative around North America Healthcare capital equipment, given customers could very easily delay orders out of the first quarter, given uncertainty?.

Yeah. By definition it has to pick up a 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. And it is clearly more North – it's we have more North America and less O-U.S.

But other than that it's essentially the forecast that we expected. And the backlog is sitting there to – for the bulk of it to ship. We do not historically see cancellations in the backlog. That is a – I mean it happens upon a rare, rare occasion. We do sometimes see push outs. But cancellations are really, really, unusual..

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 FY 2018.

Could you give us a sense of how you get there? And just kind of walk us there?.

Yeah. I mean I was specifically talking about the – I'll call the IMS piece of that business, which we – 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, I mean, 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 pace of 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..

All right. Thank you very much, guys..

Next question is from Mr. Larry Keusch from Raymond James. Your line is open..

Yeah. Just two quick ones.

First, while 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're using forward rates, what are the assumptions for the euro, peso, and Canadian dollar, and I guess pound?.

Sure. I'll address the Sterilmed question. We have been working with Sterilmed. We're in essence a contract reprocessor for the Sterilmed business. And there have been a number of changes in that businesses as we have moved forward. And so we worked with Sterilmed to do a couple things.

Find ways to improve the cost structure of the business, working together and sharing the results of that – of those savings. So we do expect to see our profitability in that business improve significantly the next little bit. So that's the answer to the first question. The second....

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 have 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..

Okay, great. Thanks, Mike..

You are welcome..

Next question is from Joel Kaufman from Goldman Sachs. Your line is open..

Hi, guys. Thanks for the question..

Joel..

Could you maybe just parse out what's driving the continued strength we're seeing at AST? And growth trends from your customers would suggest that the market growth rate there continues to be pretty robust.

Just trying to figure out if there's any market share dynamics happening behind the scenes?.

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, and just underlying growth in the space.

And then we've also seen that we have continued to do a nice and nicer job with the global manufacturers, which is one of the things we expected to see. And so I suspect that we are picking up some share in the global manufacturers, vis-à-vis either their own or local processor. 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..

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 these Synergy Health synergies.

And are there any opportunities to improve the working capital?.

Yeah. 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 the 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..

Great. Thank you..

Our next question is from – go ahead....

I would say just to 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..

Our next question is from Mr. Dave Turkaly from JPM Securities (sic) [JMP Securities]..

Hi, thanks. Just to kind of follow-up on some of the other questions.

From the competitive landscape, maybe even just specifically in the healthcare segment, is there anything new that you're seeing there? Any update that you'd give in terms of that market growth? Or anything that's changed sort of from a competitive landscape?.

No. I mean we have good competitors across the board in all of our – every space we compete in. They're 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 kind of things.

But I would call it as 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 it a significant shift any place..

And then I know it's certainly probably 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 in a percent or a dollar basis in this quarter?.

No. I don't think we would do that. We know there were slowdowns. We know we were – 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..

Okay. Thanks..

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

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

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