Introduction
In Management's Discussion and Analysis of Financial Condition and Results of Operations (the "MD&A"), we explain the general financial condition and the results of operations for STERIS including: •what factors affect our business; •what our earnings and costs were in each period presented; •why those earnings and costs were different from prior periods; •where our earnings came from; •how this affects our overall financial condition; •what our expenditures for capital projects were; and •where cash will come from to fund future debt principal repayments, growth outside of core operations, repurchases of shares, cash dividends and future working capital needs. As you read the MD&A, it may be helpful to refer to information in our consolidated financial statements, which present the results of our operations for the second quarter and first half of fiscal 2021 and fiscal 2020. It may also be helpful to read the MD&A in our Annual Report on Form 10-K for the year endedMarch 31, 2020 datedMay 29, 2020 . In the MD&A, we analyze and explain the period-over-period changes in the specific line items in the Consolidated Statements of Income. Our analysis may be important to you in making decisions about your investments in STERIS. Financial Measures In the following sections of the MD&A, we may, at times, refer to financial measures that are not required to be presented in the consolidated financial statements underU.S. GAAP. We sometimes use the following financial measures in the context of this report: backlog; debt-to-total capital; and days sales outstanding. We define these financial measures as follows: •Backlog - We define backlog as the amount of unfilled capital equipment purchase orders at a point in time. We use this figure as a measure to assist in the projection of short-term financial results and inventory requirements. •Debt-to-total capital - We define debt-to-total capital as total debt divided by the sum of total debt and shareholders' equity. We use this figure as a financial liquidity measure to gauge our ability to borrow and fund growth. •Days sales outstanding ("DSO") - We define DSO as the average collection period for accounts receivable. It is calculated as net accounts receivable divided by the trailing four quarters' revenues, multiplied by 365 days. We use this figure to help gauge the quality of accounts receivable and expected time to collect. We, at times, may also refer to financial measures which are considered to be "non-GAAP financial measures" underSEC rules. We have presented these financial measures because we believe that meaningful analysis of our financial performance is enhanced by an understanding of certain additional factors underlying that performance. These financial measures should not be considered an alternative to measures required by accounting principles generally accepted inthe United States . Our calculations of these measures may differ from calculations of similar measures used by other companies and you should be careful when comparing these financial measures to those of other companies. Additional information regarding these financial measures, including reconciliations of each non- GAAP financial measure, is available in the subsection of MD&A titled, "Non-GAAP Financial Measures." Revenues - Defined As required by Regulation S-X, we separately present revenues generated as either product revenues or service revenues on our Consolidated Statements of Income for each period presented. When we discuss revenues, we may, at times, refer to revenues summarized differently than the Regulation S-X requirements. The terminology, definitions, and applications of terms that we use to describe revenues may be different from terms used by other companies. We use the following terms to describe revenues: •Revenues - Our revenues are presented net of sales returns and allowances. •Product Revenues - We define product revenues as revenues generated from sales of consumable and capital equipment products. •Service Revenues - We define service revenues as revenues generated from parts and labor associated with the maintenance, repair, and installation of our capital equipment. Service revenues also include hospital sterilization services, instrument and scope repairs, as well as revenues generated from contract sterilization and laboratory services offered through our Applied Sterilization Technologies segment. 29 -------------------------------------------------------------------------------- Table of Contents •Capital Equipment Revenues - We define capital equipment revenues as revenues generated from sales of capital equipment, which includes: steam and gas sterilizers, low temperature liquid chemical sterilant processing systems, pure steam/water systems, surgical lights and tables, and integrated OR. •Consumable Revenues - We define consumable revenues as revenues generated from sales of the consumable family of products, which includes dedicated consumables including V-PRO, SYSTEM 1 and 1E consumables, gastrointestinal endoscopy accessories, sterility assurance products, barrier protection solutions, cleaning consumables, and surgical instruments. •Recurring Revenues - We define recurring revenues as revenues generated from sales of consumable products and service revenues.General Company Overview and Executive Summary STERIS plc is a leading provider of infection prevention and other procedural products and services. Our MISSION IS TO HELP OUR CUSTOMERS CREATE A HEALTHIER AND SAFER WORLD by providing innovative healthcare and life science product and service solutions around the globe. We offer our Customers a unique mix of innovative consumable products, such as detergents, gastrointestinal ("GI") endoscopy accessories, barrier product solutions, and other products and services, including: equipment installation and maintenance, microbial reduction of medical devices, instrument and scope repair solutions, laboratory testing services, on-site and off-site reprocessing, and capital equipment products, such as sterilizers and surgical tables, and connectivity solutions such as operating room ("OR") integration. We operate and report our financial information in three reportable business segments: Healthcare, Applied Sterilization Technologies and Life Sciences. Non-allocated operating costs that support the entire Company and items not indicative of operating trends are excluded from segment operating income. We describe our business segments in Note 9 to our consolidated financial statements, titled "Business Segment Information." The bulk of our revenues are derived from the healthcare and pharmaceutical industries. Much of the growth in these industries is driven by the aging of the population throughout the world, as an increasing number of individuals are entering their prime healthcare consumption years, and is dependent upon advancement in healthcare delivery, acceptance of new technologies, government policies, and general economic conditions. The pharmaceutical industry has been impacted by increased regulatory scrutiny of cleaning and validation processes, mandating that manufacturers improve their processes. Within healthcare, there is increased concern regarding the level of hospital acquired infections around the world; increased demand for medical procedures, including preventive screenings such as endoscopies and colonoscopies; and a desire by our Customers to operate more efficiently, all of which are driving increased demand for many of our products and services. During the first half of fiscal 2021, we experienced reduced demand for certain products and services resulting from the reduction of deferrable surgical procedures and increased demand for other products from our pharma Customers focused on vaccines and biologics, as a result of the COVID-19 pandemic. For more information on the COVID-19 pandemic please refer to the subsection below, titled "COVID-19 Pandemic". Acquisitions and Divestitures. OnOctober 2, 2020 , we entered into a purchase agreement to acquire all of the outstanding units and equity ofKey Surgical, LLC ("Key Surgical"). Key Surgical is a portfolio company ofWater Street Healthcare Partners, LLC and is a global provider of sterile processing, operating room and endoscopy consumable products serving hospitals and surgical facilities. Key Surgical is expected to be integrated into our Healthcare segment. We anticipate that the acquisition will be completed beforeDecember 31, 2020 . The purchase price is$850.0 million in cash, or approximately$810.0 million net of tax benefits, and is subject to customary adjustments. We are not assuming any pre-existing debt, and intend to fund the purchase through a combination of debt and cash on hand. OnOctober 2, 2020 , we entered into a financing commitment with several lenders providing for the establishment of a new senior unsecured three year term loan credit facility to be effective upon closing of the acquisition in the amount of$550.0 million to partially fund the acquisition. During the first half of fiscal 2020, we completed several tuck-in acquisitions which continued to expand our product offerings in the Healthcare and Applied Sterilization Technologies segments. During the first half of fiscal 2020, we sold the operations of our Healthcare Specialty Services business that were located inChina . The business generated annual revenues of approximately$5.0 million . 30 -------------------------------------------------------------------------------- Table of Contents COVID-19 Pandemic. The COVID-19 pandemic began to impact our business late in fiscal 2020. The pandemic and related public health recommendations and mandated precautions to mitigate the spread of COVID-19, including deferral of medical procedures and treatments and shelter-in-place orders or similar measures, have negatively affected and are expected to continue to negatively affect some of our operations, which may impact our financial position and cash flows. We have experienced and expect to continue to experience unpredictable fluctuations in demand for certain of our products and services, including some products and services that are experiencing increased demand. To date, we do not believe that the COVID-19 pandemic has had a significant impact on our operations, as we have been able to continue to operate our manufacturing facilities and meet the demand for essential products and services of our Customers. In response to the pandemic, we have implemented several measures that we believe will help us to protect the health and safety of our employees, preserve liquidity and enhance our financial flexibility. For our employees, we allowed employees to work remotely when possible and have implemented additional safety measures in compliance with applicable regulations to allow personnel to continue to work in our facilities. We suspended all non-essential travel and enacted a temporary hiring freeze on certain positions. To manage liquidity, we have suspended our stock repurchase program and deferred certain planned capital expenditures; however, we have continued to invest in expansion projects as planned. We do not believe that these actions will negatively impact our long-term ability to generate revenues or meet existing and future financial obligations. While we have been impacted and expect this situation to continue to have an impact on our business, the full impact to our results of operations and financial position cannot be reasonably estimated at this time. For additional information and our risk factors related to the COVID-19 pandemic, please refer to our Annual Report on Form 10-K for the year endedMarch 31, 2020 datedMay 29, 2020 . Highlights. Revenues increased 2.6%, to$756.1 million for the three months endedSeptember 30, 2020 , as compared to$736.8 million for the same period in the prior year. The increase reflects organic revenue growth in the Applied Sterilization Technologies and Life Sciences segments and favorable fluctuations in currencies, which were partially offset by a decline in the Healthcare segment. Growth in the Applied Sterilization Technologies segment was primarily due to volume as procedure volumes rebounded during our second fiscal quarter. Growth in the Life Sciences segment was due to increased demand for our products and services from our pharma Customers focused on vaccines and biologics. The decline in the Healthcare segment was primarily due to a decrease in capital equipment revenues resulting from reduced capital spending in response to the uncertainty surrounding the COVID-19 pandemic, which was partially offset by growth in consumable revenues as procedure volumes rebounded during our second fiscal quarter. Revenues decreased 0.6%, to$1,425.1 million for the six months endedSeptember 30, 2020 , as compared to$1,433.6 million for the same period in the prior year and reflects a decline in the Healthcare segment, which was partially offset by organic growth in the Applied Sterilization Technologies and Life Sciences segments and favorable fluctuations in currencies. The decline in the Healthcare segment was primarily due to reduced demand for our products and services resulting from the reduction of deferrable surgical procedures as a result of the COVID-19 pandemic, primarily during our first fiscal quarter. Growth in the Applied Sterilization Technologies segment was primarily due to higher volumes. Growth in the Life Sciences segment was due to increased demand for our products and services from our pharma Customers focused on vaccines and biologics. In the first quarter of fiscal 2021, we recognized$14.6 million of capital equipment revenues that were previously deferred (for more information regarding this change refer to Note 1 of the consolidated statements, titled "Nature of Operations and Summary of Significant Accounting Policies"). Gross profit percentage for the second quarter of fiscal 2021 was 43.6% compared to the gross profit percentage for the second quarter of fiscal 2020 of 43.2%. The favorable impacts of pricing, favorable mix and improved productivity, were partially offset by incremental costs associated with COVID-19. Gross profit percentage for the first half of fiscal 2021 was 43.2% compared to the gross profit percentage for the first half of fiscal 2020 of 43.6%. The unfavorable impacts of incremental costs associated with COVID-19 and a decline in productivity, exceeded the benefits of favorable pricing and favorable mix. Operating income for the second quarter of fiscal 2021 was$141.3 million , compared to$126.7 million for second quarter of fiscal 2020. Operating income during the first half of fiscal 2021 was$255.3 million , compared to$236.8 million for the first half of fiscal 2020. These increases were primarily attributable to lower selling, general, and administrative ("SG&A") expenses during the fiscal 2021 periods, as certain expenses were suspended or reduced as a result of the COVID-19 pandemic and an increase in volumes over the prior year for the quarter to date period. Cash flows from operations were$296.1 million and free cash flow was$185.6 million in the first half of fiscal 2021 compared to cash flows from operations of$260.0 million and free cash flow of$162.0 million for first half of fiscal 2020 (see the subsection below titled "Non-GAAP Financial Measures" for additional information and related reconciliation of cash flows from operations to free cash flow). The fiscal 2021 increases in cash flows from operations and free cash flow were primarily due to working capital improvements and deferred tax payments under government COVID-19 relief programs. Our debt-to-total capital ratio was 21.9% atSeptember 30, 2020 and 25.3% atMarch 31, 2020 . During the first half of fiscal 2021, we declared and paid quarterly cash dividends of$0.77 per ordinary share. 31 -------------------------------------------------------------------------------- Table of Contents Additional information regarding our financial performance during the second quarter and first half of fiscal 2021 is included in the subsection below titled "Results of Operations." NON-GAAP FINANCIAL MEASURES We, at times, refer to financial measures which are considered to be "non-GAAP financial measures" underSEC rules. We, at times, also refer to our results of operations excluding certain transactions or amounts that are non-recurring or are not indicative of future results, in order to provide meaningful comparisons between the periods presented. These non-GAAP financial measures are not intended to be, and should not be, considered separately from or as an alternative to the most directly comparable GAAP financial measures. These non-GAAP financial measures are presented with the intent of providing greater transparency to supplemental financial information used by management and the Board of Directors in their financial analysis and operational decision-making. These amounts are disclosed so that the reader has the same financial data that management uses with the belief that it will assist investors and other readers in making comparisons to our historical operating results and analyzing the underlying performance of our operations for the periods presented. We believe that the presentation of these non-GAAP financial measures, when considered along with our GAAP financial measures and the reconciliation to the corresponding GAAP financial measures, provide the reader with a more complete understanding of the factors and trends affecting our business than could be obtained absent this disclosure. It is important for the reader to note that the non-GAAP financial measure used may be calculated differently from, and therefore may not be comparable to, a similarly titled measure used by other companies. We define free cash flow as net cash provided by operating activities as presented in the Consolidated Statements of Cash Flows less purchases of property, plant, equipment, and intangibles plus proceeds from the sale of property, plant, equipment, and intangibles, which are also presented within investing activities in the Consolidated Statements of Cash Flows. We use this as a measure to gauge our ability to pay cash dividends, fund growth outside of core operations, fund future debt principal repayments, and repurchase shares. The following table summarizes the calculation of our free cash flow for the six months endedSeptember 30, 2020 and 2019: Six Months Ended September 30, (dollars in thousands) 2020 2019 Net cash provided by operating activities$ 296,073 $ 260,000 Purchases of property, plant, equipment and intangibles, net (110,746) (98,168) Proceeds from the sale of property, plant, equipment and intangibles 275 206 Free cash flow$ 185,602 $ 162,038 Results of Operations In the following subsections, we discuss our earnings and the factors affecting them for the second quarter and first half of fiscal 2021 compared with the same fiscal 2020 periods. We begin with a general overview of our operating results and then separately discuss earnings for our operating segments. 32 -------------------------------------------------------------------------------- Table of Contents Revenues. The following tables compare our revenues for the three and six months endedSeptember 30, 2020 to the revenues for the three and six months endedSeptember 30, 2019 : Three Months Ended September 30, (dollars in thousands) 2020 2019 Change Percent Change Total revenues$ 756,132 $ 736,840 $ 19,292 2.6 % Revenues by type: Service revenues 416,628 399,174 17,454 4.4 % Consumable revenues 178,590 158,573 20,017 12.6 % Capital equipment revenues 160,914 179,093 (18,179) (10.2) % Revenues by geography: Ireland revenues 17,090 15,171 1,919 12.6 % United States revenues 549,449 538,101 11,348 2.1 % Other foreign revenues 189,593 183,568 6,025 3.3 % Revenues increased 2.6%, to$756.1 million for the three months endedSeptember 30, 2020 , as compared to$736.8 million for the same period in the prior year. This increase reflects organic growth in the Applied Sterilization Technologies and Life Sciences segments and favorable fluctuations in currencies, which were partially offset by a decline in the Healthcare segment. Growth in the Applied Sterilization Technologies segment was primarily due to volume as procedure volumes rebounded during our second fiscal quarter. Growth in the Life Sciences segment was due to increased demand for our products and services from our pharma Customers focused on vaccines and biologics. The decline in the Healthcare segment was primarily due to a decrease in capital equipment revenues resulting from reduced capital spending in response to the uncertainty surrounding the COVID-19 pandemic, which was partially offset by growth in consumable revenues as procedure volumes rebounded during our second fiscal quarter. Service revenues increased 4.4% for the three months endedSeptember 30, 2020 , as compared to the same period in the prior year, reflecting growth in the Applied Sterilization Technologies and Life Sciences business segments, partially offset by a slight decline in the Healthcare segment. Consumable revenues increased by 12.6% for the three months endedSeptember 30, 2020 , as compared to the same period in the prior year, reflecting growth in the Healthcare and Life Sciences segments. Capital equipment revenues decreased 10.2%, for the three months endedSeptember 30, 2020 , as compared to the same period in the prior year, reflecting decline in the Healthcare segment, which was partially offset by growth in the Life Sciences segment. The decline in the Healthcare segment was primarily due to reduced capital spending in response to the uncertainty surrounding the COVID-19 pandemic.Ireland revenues increased 12.6% to$17.1 million for the three months endedSeptember 30, 2020 , as compared to$15.2 million for the same period in the prior year, reflecting growth in service, consumable and capital equipment revenues.United States revenues increased 2.1%, to$549.4 million for the three months endedSeptember 30, 2020 , as compared to$538.1 million for the same period in the prior year, reflecting growth in service and consumable revenues, which were partially offset by decline in capital equipment revenues. Revenues from other foreign locations, increased 3.3%, to$189.6 million for the three months endedSeptember 30, 2020 , as compared to$183.6 million for the same period in the prior year. Growth withinCanada and theEurope ,Middle East &Africa ("EMEA") andAsia Pacific regions was partially offset by a decline in the Latin American region. 33
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Table of Contents Six Months Ended September 30, (dollars in thousands) 2020 2019 Change Percent Change Total revenues$ 1,425,064 $ 1,433,643 $ (8,579) (0.6) % Revenues by type: Service revenues 784,452 788,242 (3,790) (0.5) % Consumable revenues 321,186 318,684 2,502 0.8 % Capital equipment revenues 319,426 326,717 (7,291) (2.2) % Revenues by geography: Ireland revenues 31,463 30,279 1,184 3.9 % United States revenues 1,041,157 1,049,253 (8,096) (0.8) % Other foreign revenues 352,444 354,111 (1,667) (0.5) % Revenues decreased 0.6%, to$1,425.1 million for the six months endedSeptember 30, 2020 , as compared to$1,433.6 million for the same period in the prior year. The decrease reflects a decline in the Healthcare segment which was partially offset by organic growth in the Applied Sterilization Technologies and Life Sciences segments and favorable fluctuations in currencies. The decline in the Healthcare segment revenues was primarily due to reduced demand for our products and services resulting from the reduction of deferrable surgical procedures as a result of the COVID-19 pandemic, primarily during our first fiscal quarter. Growth in the Applied Sterilization Technologies segment was primarily due to volume. Growth in the Life Sciences segment was due to increased demand for our products and services from our pharma Customers focused on vaccines and biologics. In the first quarter of fiscal 2021, we recognized$14.6 million of capital equipment revenues that were previously deferred (for more information regarding this change refer to Note 1 of the consolidated statements, titled "Nature of Operations and Summary of Significant Accounting Policies"). Service revenues decreased 0.5% for the six months endedSeptember 30, 2020 , as compared to the same period in the prior year, reflecting decline in the Healthcare segment, which was partially offset by growth in the Applied Sterilization and Life Science segments. Consumable revenues increased by 0.8% for the six months endedSeptember 30, 2020 , as compared to the same period in the prior year, reflecting growth in the Life Sciences segment, which was partially offset by a decline in the Healthcare segment. Capital equipment revenues decreased 2.2% for the six months endedSeptember 30, 2020 , as compared to to the same period in the prior year, reflecting decline in the Healthcare segment, which was partially offset by growth in the Life Sciences segment. In the first quarter of fiscal 2021, we recognized$14.6 million of capital equipment revenues that were previously deferred (for more information regarding this change refer to Note 1 of the consolidated statements, titled "Nature of Operations and Summary of Significant Accounting Policies").Ireland revenues increased 3.9% to$31.5 million for the six months endedSeptember 30, 2020 , as compared to$30.3 million for the same period in the prior year, reflecting growth in service and consumable revenues, which were partially offset by a decline in capital equipment revenues.United States revenues decreased 0.8%, to$1,041.2 million for the six months endedSeptember 30, 2020 , as compared to$1,049.3 million for the same period in the prior year, reflecting declines in service and capital equipment revenues, which were partially offset by growth in consumable revenues. In the first quarter of fiscal 2021, we recognized$14.6 million of capital equipment revenues that were previously deferred (for more information regarding this change refer to Note 1 of the consolidated statements, titled "Nature of Operations and Summary of Significant Accounting Policies"). Revenues from other foreign locations decreased 0.5%, to$352.4 million for the six months endedSeptember 30, 2020 , as compared to$354.1 million for the same period in the prior year. Declines in the EMEA and Latin American regions were partially offset by growth inCanada and in theAsia Pacific region. 34 -------------------------------------------------------------------------------- Table of Contents Gross Profit. The following table compares our gross profit for the three and six months endedSeptember 30, 2020 to the three and six months endedSeptember 30, 2019 : Three Months Ended September 30, Percent (dollars in thousands) 2020 2019 Change Change Gross profit: Product$ 163,706 $ 154,066 $ 9,640 6.3 % Service 166,331 164,601 1,730 1.1 % Total gross profit$ 330,037 $ 318,667 $ 11,370 3.6 %
Gross profit percentage: Product 48.2 % 45.6 % Service 39.9 % 41.2 % Total gross profit percentage 43.6 % 43.2 % Six Months Ended September 30, Percent (dollars in thousands) 2020
2019 Change Change Gross profit: Product$ 308,259 $ 300,842 $ 7,417 2.5 % Service 307,346 323,668 (16,322) (5.0) % Total gross profit$ 615,605 $ 624,510 $ (8,905) (1.4) % Gross profit percentage: Product 48.1 % 46.6 % Service 39.2 % 41.1 % Total gross profit percentage 43.2 %
43.6 %
Our gross profit is affected by the volume, pricing, and mix of sales of our products and services, as well as the costs associated with the products and services that are sold. Gross profit percentage for the second quarter of fiscal 2021 was 43.6% compared to the gross profit percentage for the second quarter of fiscal 2020 of 43.2%. The favorable impacts of pricing (60 basis points), favorable mix (20 basis points) and improved productivity (20 basis points), were partially offset by incremental costs associated with COVID-19 (60 basis points). Gross profit percentage for the first half of fiscal 2021 was 43.2% compared to the gross profit percentage for the first half of fiscal 2020 of 43.6%. The unfavorable impacts of incremental costs associated with COVID-19 (90 basis points) and a decline in productivity (60 basis points), exceeded the benefits of favorable pricing (50 basis points) and favorable mix (60 basis points). Operating Expenses. The following table compares our operating expenses for the three and six months endedSeptember 30, 2020 to the three and six months endedSeptember 30, 2019 : Three Months Ended September 30, Percent (dollars in thousands) 2020 2019 Change Change Operating expenses: Selling, general, and administrative$ 172,707 $ 175,959 $ (3,252) (1.8) % Research and development 16,143 16,249 (106) (0.7) % Restructuring expenses (76) (274) 198 NM Total operating expenses$ 188,774 $ 191,934 $ (3,160) (1.6) % Six Months Ended September 30, Percent (dollars in thousands) 2020 2019 Change Change Operating expenses: Selling, general, and administrative$ 327,877 $ 354,740 $ (26,863) (7.6) % Research and development 32,374 31,834 540 1.7 % Restructuring expenses 90 1,115 (1,025) NM Total operating expenses$ 360,341 $ 387,689 $ (27,348) (7.1) % NM - Not meaningful. 35
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Selling, General, and Administrative Expenses. Significant components of total selling, general, and administrative expenses ("SG&A") are compensation and benefit costs, fees for professional services, travel and entertainment, facilities costs, and other general and administrative expenses. SG&A decreased 1.8% and 7.6% in the second quarter and first half of fiscal 2021, respectively over the same prior year periods. Volume and performance driven employee compensation costs and travel and meeting costs have declined as a result of the COVID-19 pandemic and measures we have taken in response to it. Research and Development. Research and development expenses decreased 0.7% and increased 1.7% in the second quarter and first half of fiscal 2021, respectively over the same prior year periods. Research and development expenses are influenced by the number and timing of in-process projects and labor hours and other costs associated with these projects. Our research and development initiatives continue to emphasize new product development, product improvements, and the development of new technological platform innovations. During fiscal 2021, our investments in research and development continued to be focused on, but were not limited to, enhancing capabilities of sterile processing combination technologies, procedural products and accessories, and devices and support accessories used in gastrointestinal endoscopy procedures. Fiscal 2019 Restructuring Plan. Since inception of the Fiscal 2019 Restructuring Plan we have incurred pre-tax expenses totaling$43.9 million related to these restructuring actions, of which$31.8 million was recorded as restructuring expenses and$12.2 million was recorded in cost of revenues, with a total of$34.1 million ,$7.5 million and$0.7 million related to the Healthcare, Applied Sterilization Technologies and Life Sciences segments, respectively. Corporate related restructuring charges were$1.7 million . Additional restructuring expenses related to this plan are not expected to be material to our results of operations. Additional restructuring expenses related to this plan are not expected to be material to our results of operations. For additional information on restructuring see Note 2 of our Consolidated Financial Statements, titled "Restructuring". Non-Operating Expenses, Net. Non-operating expenses, net consists of interest expense on debt, offset by interest earned on cash, cash equivalents, and short-term investment balances, and other miscellaneous income. The following table compares our net non-operating expenses for the three and six months endedSeptember 30, 2020 and 2019: Three Months Ended September 30, (dollars in thousands) 2020 2019 Change Non-operating expenses, net: Interest expense $ 8,665$ 10,444 $ (1,779) Interest income and miscellaneous expense (1,188) (1,018) (170) Non-operating expenses, net $ 7,477$ 9,426 $ (1,949) Six Months Ended September 30, (dollars in thousands) 2020 2019 Change Non-operating expenses, net: Interest expense $ 18,157$ 20,889 $ (2,732) Interest income and miscellaneous expense (3,477) (785) (2,692) Non-operating expenses, net $ 14,680$ 20,104 $ (5,424) Interest expense decreased$1.8 million and$2.7 million during the second quarter and first half of fiscal 2021, respectively over the same prior year periods. These decreases were primarily due to lower interest rates on floating rate debt. Interest (income) and miscellaneous expense changed by$0.2 million and$2.7 million , during the second quarter and first half of fiscal 2021, respectively over the same prior year periods, primarily due to movement on our equity investments (refer to our Note 15 to our consolidated financial statements, titled "Fair Value Measurements" for more information). Income Tax Expense. The following table compares our income tax expense and effective income tax rates for the three and six months endedSeptember 30, 2020 andSeptember 30, 2019 : Three Months Ended September 30, Percent (dollars in thousands) 2020 2019 Change Change Income tax expense$ 27,778 $ 22,165 $ 5,613 25.3% Effective income tax rate 20.8 % 18.9 % 36
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Table of Contents Six Months Ended September 30, Percent (dollars in thousands) 2020 2019 Change Change Income tax expense$ 46,452 $ 36,798 $ 9,654 26.2% Effective income tax rate 19.3 % 17.0 % We record income tax expense during interim periods based on our estimate of the annual effective income tax rate, adjusted each quarter for discrete items. We analyze various factors to determine the estimated annual effective income tax rate, including projections of our annual earnings and taxing jurisdictions in which the earnings will be generated, the impact of state and local income taxes, our ability to use tax credits and net operating loss carryforwards, and available tax planning alternatives. The effective income tax rates for the three month periods endedSeptember 30, 2020 and 2019 were 20.8% and 18.9%, respectively. The effective income tax rates for the six month periods endedSeptember 30, 2020 and 2019 were 19.3% and 17.0%, respectively. The fiscal 2021 effective tax rates increased as compared to the fiscal 2020 periods, primarily due to an increased percentage of profits earned and taxed in jurisdictions with a higher tax rate. Business Segment Results of Operations. We operate and report in three reportable business segments: Healthcare, Applied Sterilization Technologies and Life Sciences. Non-allocated operating costs that support the entire Company and items not indicative of operating trends are excluded from segment operating income. COVID-19 incremental costs also have been excluded from segment operating income. These costs include payroll costs associated with employees paid but not working as a result of measures taken in response to the COVID-19 pandemic. Prior toApril 1, 2020 , we operated and reported our financial information in four reportable business segments: Healthcare Products, Healthcare Specialty Services, Life Sciences, and Applied Sterilization Technologies. The Healthcare Products and Healthcare Specialty Services segments were combined and are now reported as one segment, simply called Healthcare, consistent with the way management now operates and views the business. Prior periods have been recast in the financial tables below for comparability. Our Healthcare segment offers infection prevention and procedural solutions for healthcare providers worldwide, including consumable products, equipment maintenance and installation services, and capital equipment. The segment also provides a range of specialty services for healthcare providers including hospital sterilization services and instrument and scope repairs. Our Applied Sterilization Technologies ("AST") segment provides contract sterilization and testing services for medical device and pharmaceutical manufacturers. Our Life Sciences segment designs, manufactures and sells consumable products, equipment maintenance, specialty services and capital equipment primarily to pharmaceutical manufacturers around the world. We disclose a measure of segment income that is consistent with the way management operates and views the business. The accounting policies for reportable segments are the same as those for the consolidated Company. Additional information regarding our segments is included in our consolidated financial statements included in our Annual Report on Form 10-K for the year endedMarch 31, 2020 , datedMay 29, 2020 . 37 -------------------------------------------------------------------------------- Table of Contents The following table compares business segment revenues, segment operating income and total operating income for the three and six months endedSeptember 30, 2020 and 2019: Financial information for each of our segments is presented in the following table: Three Months Ended September 30, Six Months Ended September 30, (dollars in thousands) 2020 2019 2020 2019 Revenues: Healthcare$ 470,927
169,547 152,907 321,909 307,193 Life Sciences 115,658 98,650 232,570 195,435 Total revenues$ 756,132 $ 736,840 $ 1,425,064 $ 1,433,643 Operating income (loss): Healthcare$ 104,796
76,835 65,386 140,790 133,421 Life Sciences 46,433 32,315 94,894 65,354 Corporate (58,155) (50,956) (110,522) (106,353) Total operating income before adjustments$ 169,909
$ 21,955
1,135 1,947 2,421 3,864 Redomiciliation and tax restructuring costs (3) 384 1,016 554 2,786 Net (gain) loss on divestiture of businesses (1) (5) 50 5 2,476 Amortization of property "step up" to fair value (1) 714 446 1,317 1,181 COVID-19 incremental costs (4) 4,539 - 13,209 - Restructuring charges (5) (76) 636 90 2,943 Total operating income$ 141,263 $ 126,733 $ 255,264 $ 236,821 (1) For more information regarding our recent acquisitions and divestitures refer to our Annual Report on Form 10-K for the year endedMarch 31, 2020 , datedMay 29, 2020 . (2) Acquisition and integration related charges include transaction costs and integration expenses associated with acquisitions. (3) Costs incurred in connection with the Redomiciliation. (4) COVID-19 incremental costs includes the additional costs attributable to COVID-19 such as enhanced cleaning protocols, personal protective equipment for our employees, event cancellation fees, and payroll costs associated with our response to COVID-19, net of any government subsidies available. (5) For more information regarding our restructuring efforts refer to Note 2 titled, "Restructuring". Healthcare revenues decreased 3.0% to$470.9 million for the three months endedSeptember 30, 2020 , as compared to$485.3 million in the same prior year period. Capital equipment revenue declined 13.7%, primarily due to reduced capital spending in response to the uncertainty surrounding the COVID-19 pandemic. Consumables revenues grew 5.8%, as procedure volumes rebounded during our second fiscal quarter. Service revenues were essentially flat. Healthcare revenues decreased 6.5% to$870.6 million for the six months endedSeptember 30, 2020 , as compared to$931.0 million in the same prior year period. This decrease reflects declines in consumable, capital equipment and service revenues of 11.0%, 5.0% and 5.0%, respectively. The decline in the Healthcare segment revenues was primarily due to reduced demand for our products and services resulting from the reduction of deferrable surgical procedures as a result of the COVID-19 pandemic, primarily during our first fiscal quarter. Fluctuations in currencies were favorable during the second quarter and unfavorable during the first half of fiscal 2021. AtSeptember 30, 2020 , the Healthcare segment's backlog amounted to$178.0 million , representing a decrease of 10.7%, as compared to the backlog of$199.3 million atSeptember 30, 2019 . A significant portion of this decrease was related to the recognition of capital equipment revenues that were previously deferred (for more information regarding this change refer to Note 1 of the consolidated statements, titled "Nature of Operations and Summary of Significant Accounting Policies"). Applied Sterilization Technologies segment revenues increased 10.9% to$169.5 million for the three months endedSeptember 30, 2020 , as compared to$152.9 million for the same prior year period. Applied Sterilization Technologies segment revenues increased 4.8% to$321.9 million for the six months endedSeptember 30, 2020 , as compared to$307.2 million for the same prior year period. The fiscal 2021 increases reflect organic growth and favorable fluctuations in currencies. 38 -------------------------------------------------------------------------------- Table of Contents Life Sciences revenues increased 17.2% to$115.7 million for the three months endedSeptember 30, 2020 , as compared to$98.7 million for the same prior year period. This increase reflects growth in consumable, capital equipment and service revenues of 31.2% 10.5% and 3.3%, respectively. Life Sciences revenues increased 19.0% to$232.6 million for the six months endedSeptember 30, 2020 , as compared to$195.4 million for the same prior year period. This increase reflects growth in consumable, capital equipment and service revenues of 32.4% 12.1% and 4.7%, respectively. The fiscal 2021 increases reflect organic growth due to demand from our pharma Customers focused on vaccines and biologics and favorable fluctuations in currencies. AtSeptember 30, 2020 , the Life Sciences segment's backlog amounted to$74.8 million , representing an increase of 7.3%, as compared to the backlog of$69.7 million atSeptember 30, 2019 . The Healthcare segment's operating income increased 1.7% to$104.8 million for the three months endedSeptember 30, 2020 , as compared to$103.0 million in the same prior year period. The segment's operating margins were 22.3% and 21.2% for the second quarter of fiscal 2021 and 2020, respectively. These increases were primarily due to reduced expenditures, including reductions in travel and meeting spend due to the COVID-19 pandemic. The Healthcare segment's operating income decreased 3.3% to$187.2 million for the six months endedSeptember 30, 2020 , as compared to$193.6 million in the same prior year period, primarily due to lower volumes. The segment's operating margins were 21.5% and 20.8% for the first half of fiscal 2021 and 2020, respectively. The segment's operating margin improvement was primarily due to reduced expenditures, including reductions in travel and meeting spend due to the COVID-19 pandemic. Employee compensation allocated to the Healthcare segment was also reduced due to lower volumes and measures taken in response to the COVID-19 pandemic. The Applied Sterilization Technologies segment's operating income increased 17.5% to$76.8 million for the three months endedSeptember 30, 2020 , as compared to$65.4 million during the same prior year period. The Applied Sterilization Technologies segment's operating income increased 5.5% to$140.8 million for the six months endedSeptember 30, 2020 , as compared to$133.4 million during the same prior year period. The segment's operating margins were 45.3% and 42.8% for the second quarter fiscal 2021 and 2020, respectively. The segment's operating margins were 43.7% and 43.4% for the first half of fiscal 2021 and 2020, respectively. These increases in the fiscal 2021 periods were primarily due to higher volumes and reduced expenditures, including reductions in travel and meeting spend due to the COVID-19 pandemic. The Life Sciences segment's operating income increased 43.7% to$46.4 million for the three months endedSeptember 30, 2020 , as compared to$32.3 million in the same prior year period. The Life Sciences segment's operating income increased 45.2% to$94.9 million for the six months endedSeptember 30, 2020 , as compared to$65.4 million in the same prior year period. The segment's operating margins were 40.1% and 32.8% for the second quarter of fiscal 2021 and 2020, respectively. The segment's operating margins were 40.8% and 33.4% for the first half of fiscal 2021 and 2020, respectively. These increases in the fiscal 2021 periods were primarily due to higher volumes and favorable mix. Liquidity and Capital Resources The following table summarizes significant components of our cash flows for the six months endedSeptember 30, 2020 and 2019: Six Months Ended September 30, (dollars in thousands) 2020 2019 Net cash provided by operating activities$ 296,073 $ 260,000 Net cash (used in) investing activities$ (112,863) $ (185,458) Net cash (used in) provided by financing activities$ (199,319) $ (63,529) Debt-to-total capital ratio 21.9 % 26.9 % Free cash flow$ 185,602 $ 162,038 Net Cash Provided by Operating Activities - The net cash provided by our operating activities was$296.1 million for the first six months of fiscal 2021 and$260.0 million for the first six months of fiscal 2020. The increase in cash from operations was primarily due to working capital improvements and deferred tax payments under government COVID-19 relief programs.Net Cash Used In Investing Activities - The net cash used in investing activities totaled$112.9 million for the first six months of fiscal 2021 and$185.5 million for the first six months of fiscal 2020. The following discussion summarizes the significant changes in our investing cash flows for the first six months of fiscal 2021 and fiscal 2020: •Purchases of property, plant, equipment, and intangibles, net - Capital expenditures were$110.7 million for the first six months of fiscal 2021 and$98.2 million during the same prior year period. The fiscal 2021 increase was primarily due to expansion projects in the Applied Sterilization Technologies segment. 39 -------------------------------------------------------------------------------- Table of Contents •Acquisitions of businesses, net of cash acquired - During the first six months of fiscal 2020, we used$87.9 million , for the purchase of businesses. For more information on our acquisitions, refer to our Note 17 to our consolidated financial statements, "Business Acquisitions and Divestitures". •Other - During the first six months of fiscal 2021, we provided$2.4 million under borrowing agreements. For more information on these loan agreements, refer to our Note 18 to our consolidated financial statements, "Loans Receivable".Net Cash Used In Financing Activities - The net cash used in financing activities amounted to$199.3 million for the first six months of fiscal 2021 compared with net cash used in financing activities of$63.5 million for the first six months of fiscal 2020. The following discussion summarizes the significant changes in our financing cash flows for the first six months of fiscal 2021 and fiscal 2020: •Payments on long-term obligations - During the second quarter of fiscal 2021, we repaid$35.0 million of principal for private placement notes that matured inAugust 2020 . For more information on our debt refer to our Annual Report on Form 10-K for the year endedMarch 31, 2020 , datedMay 29, 2020 . •Proceeds (payments) under credit facility, net - Net payments under credit facilities totaled$107.2 million in the first six months of fiscal 2021 compared to net proceeds under credit facilities of$13.2 million in the first six months of fiscal 2020. •Repurchases of ordinary shares - From the start of fiscal 2021 throughApril 9, 2020 , we purchased 35,000 of our ordinary shares in the aggregate amount of$5.0 million . During the first six months of fiscal 2021, we obtained 76,286 of our ordinary shares in connection with share-based compensation award programs in the aggregate amount of$9.4 million . During the first six months of fiscal 2020, we purchased of 204,414 of our ordinary shares in the aggregate amount of$29.9 million . During the first six months of fiscal 2020, we obtained 73,914 of our ordinary shares in connection with share-based compensation award programs in the aggregate amount of$8.0 million . Due to the uncertainty surrounding the COVID-19 pandemic, share repurchases were suspended onApril 9, 2020 . •Cash dividends paid to ordinary shareholders - During the first six months of fiscal 2021, we paid total cash dividends of$65.6 million , or$0.77 per outstanding share. During the first six months of fiscal 2020, we paid total cash dividends of$60.2 million , or$0.71 per outstanding share. •Contributions from noncontrolling interest - During the first six months of fiscal 2021, we received contributions from noncontrolling interest holders of$2.3 million . •Stock option and other equity transactions, net - We generally receive cash for issuing shares under our stock option programs. During the first six months of fiscal 2021 and fiscal 2020, we received cash proceeds totaling$20.6 million and$23.0 million , respectively, under these programs. Cash Flow Measures. Free cash flow was$185.6 million in the first six months of fiscal 2021 compared to$162.0 million in the first six months of fiscal 2020 (see the subsection above titled "Non-GAAP Financial Measures" for additional information and related reconciliation of cash flows from operations to free cash flow). The increase in free cash flow was primarily due to working capital improvements and deferred tax payments under government COVID-19 relief programs. Our debt-to-total capital ratio was 21.9% atSeptember 30, 2020 and 26.9% atSeptember 30, 2019 . Sources of Credit and Contractual and Commercial Commitments. Information related to our sources of credit and contractual and commercial commitments is included in our Annual Report on Form 10-K for the year endedMarch 31, 2020 , datedMay 29, 2020 . Our commercial commitments were approximately$76.6 million atSeptember 30, 2020 , reflecting a net decrease of$3.6 million in surety bonds and other commercial commitments fromMarch 31, 2020 . We had$170.3 million of outstanding borrowings under the Credit Agreement as ofSeptember 30, 2020 . We had$8.6 million of letters of credit outstanding under the Credit Agreement atSeptember 30, 2020 . Cash Requirements. We intend to use our existing cash and cash equivalent balances and cash generated from operations for short-term and long-term capital expenditures and our other liquidity needs. Our capital requirements depend on many uncertain factors, including our rate of sales growth, our Customers' acceptance of our products and services, the costs of obtaining adequate manufacturing capacities, the timing and extent of our research and development projects, changes in our expenses and other factors. To the extent that existing and anticipated sources of cash are not sufficient to fund our future activities, we may need to raise additional funds through additional borrowings or the sale of equity securities. There can be no assurance that our existing financing arrangements will provide us with sufficient funds or that we will be able to obtain any additional funds on terms favorable to us or at all. In this regard, we have obtained a$550.0 million term loan commitment from a group of banks to fund a portion of the purchase price for the recently announced Key Surgical acquisition. 40 -------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies, Estimates, and Assumptions Information related to our critical accounting policies, estimates, and assumptions is included in our Annual Report on Form 10-K for the year endedMarch 31, 2020 , datedMay 29, 2020 . Our critical accounting policies, estimates, and assumptions have not changed materially fromMarch 31, 2020 . Contingencies We are, and will likely continue to be, involved in a number of legal proceedings, government investigations, and claims, which we believe generally arise in the course of our business, given our size, history, complexity, and the nature of our business, products, Customers, regulatory environment, and industries in which we participate. These legal proceedings, investigations and claims generally involve a variety of legal theories and allegations, including, without limitation, personal injury (e.g., slip and falls, burns, vehicle accidents), product liability or regulation (e.g., based on product operation or claimed malfunction, failure to warn, failure to meet specification, or failure to comply with regulatory requirements), product exposure (e.g., claimed exposure to chemicals, asbestos, contaminants, radiation), property damage (e.g., claimed damage due to leaking equipment, fire, vehicles, chemicals), commercial claims (e.g., breach of contract, economic loss, warranty, misrepresentation), financial (e.g., taxes, reporting), employment (e.g., wrongful termination, discrimination, benefits matters), and other claims for damage and relief. We record a liability for such contingencies to the extent we conclude that their occurrence is both probable and estimable. We consider many factors in making these assessments, including the professional judgment of experienced members of management and our legal counsel. We have made estimates as to the likelihood of unfavorable outcomes and the amounts of such potential losses. In our opinion, the ultimate outcome of these proceedings and claims is not anticipated to have a material adverse affect on our consolidated financial position, results of operations, or cash flows. However, the ultimate outcome of proceedings, government investigations, and claims is unpredictable and actual results could be materially different from our estimates. We record expected recoveries under applicable insurance contracts when we are assured of recovery. Refer to Note 8 of our consolidated financial statements titled, "Commitments and Contingencies" for additional information and to Item 1A of Part II titled, "Risk factors". We are subject to taxation fromUnited States federal, state and local, and non-U.S. jurisdictions. Tax positions are settled primarily through the completion of audits within each individual tax jurisdiction or the closing of a statute of limitation. Changes in applicable tax law or other events may also require us to revise past estimates. TheIRS routinely conducts audits of our federal income tax returns. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements, that have or are reasonably likely to have, a material current or future impact on our financial condition, changes in financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital. Forward-Looking Statements This quarterly report may contain statements concerning certain trends, expectations, forecasts, estimates, or other forward-looking information affecting or relating to STERIS or its industry, products or activities that are intended to qualify for the protections afforded "forward-looking statements" under the Private Securities Litigation Reform Act of 1995 and other laws and regulations. Forward-looking statements speak only as to the date the statement is made and may be identified by the use of forward-looking terms such as "may," "will," "expects," "believes," "anticipates," "plans," "estimates," "projects," "targets," "forecasts," "outlook," "impact," "potential," "confidence," "improve," "optimistic," "deliver," "orders," "backlog," "comfortable," "trend", and "seeks," or the negative of such terms or other variations on such terms or comparable terminology. Many important factors could cause actual results to differ materially from those in the forward-looking statements including, without limitation, disruption of production or supplies, changes in market conditions, political events, pending or future claims or litigation, competitive factors, technology advances, actions of regulatory agencies, and changes in laws, government regulations, labeling or product approvals or the application or interpretation thereof. Other risk factors are described herein and in STERIS's other securities filings, including Item 1A of our Annual Report on Form 10-K for the year endedMarch 31, 2020 , filed with theSEC onMay 29, 2020 . Many of these important factors are outside of STERIS's control. No assurances can be provided as to any result or the timing of any outcome regarding matters described in STERIS's securities filings or otherwise with respect to any regulatory action, administrative proceedings, government investigations, litigation, warning letters, cost reductions, business strategies, earnings or revenue trends or future financial results. References to products are summaries only and should not be considered the specific terms of the product clearance or literature. Unless legally required, STERIS does not undertake to update or revise any forward-looking statements even if events make clear that any projected results, express or implied, will not be realized. Other potential risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements include, without limitation, (a) the impact of the COVID-19 pandemic on STERIS's operations, performance, results, prospects, or value, (b) STERIS's ability to achieve the expected benefits regarding the 41
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Table of Contents accounting and tax treatments of the Redomiciliation transaction, (c) operating costs, Customer loss and business disruption (including, without limitation, difficulties in maintaining relationships with employees, Customers, clients or suppliers) being greater than expected following the Redomiciliation, (d) STERIS's ability to meet expectations regarding the accounting and tax treatment of the Tax Cuts and Jobs Act ("TCJA") or the possibility that anticipated benefits resulting from the TCJA will be less than estimated, (e) changes in tax laws or interpretations that could increase our consolidated tax liabilities, including changes in tax laws that would result in STERIS being treated as a domestic corporation forUnited States federal tax purposes, (f) the potential for increased pressure on pricing or costs that leads to erosion of profit margins, (g) the possibility that market demand will not develop for new technologies, products or applications or services, or business initiatives will take longer, cost more or produce lower benefits than anticipated, (h) the possibility that application of or compliance with laws, court rulings, certifications, regulations, regulatory actions, including without limitation those relating to FDA warning notices or letters, government investigations, the outcome of any pending FDA requests, inspections or submissions, or other requirements or standards may delay, limit or prevent new product introductions, affect the production and marketing of existing products or services or otherwise affect STERIS's performance, results, prospects or value, (i) the potential of international unrest, economic downturn or effects of currencies, tax assessments, tariffs and/or other trade barriers, adjustments or anticipated rates, raw material costs or availability, benefit or retirement plan costs, or other regulatory compliance costs, (j) the possibility of reduced demand, or reductions in the rate of growth in demand, for STERIS's products and services, (k) the possibility of delays in receipt of orders, order cancellations, or delays in the manufacture or shipment of ordered products or in the provision of services, (l) the possibility that anticipated growth, cost savings, new product acceptance, performance or approvals, or other results may not be achieved, or that transition, labor, competition, timing, execution, regulatory, governmental, or other issues or risks associated with STERIS's businesses, industry or initiatives including, without limitation, those matters described in our Form 10-K for the year endedMarch 31, 2020 , filed with theSEC onMay 29, 2020 , and other securities filings, may adversely impact STERIS's performance, results, prospects or value, (m) the impact on STERIS and its operations, or tax liabilities, of Brexit or the exit of other member countries from the EU, and the Company's ability to respond to such impacts, (n) the impact on STERIS and its operations of any legislation, regulations or orders, including but not limited to any new trade or tax legislation, regulations or orders, that may be implemented by theU.S. administration orCongress , or of any responses thereto, (o) the possibility that anticipated financial results or benefits of recent acquisitions, including the acquisition of Key Surgical, or of STERIS's restructuring efforts, or of recent divestitures will not be realized or will be other than anticipated, (p) the effects of contractions in credit availability, as well as the ability of STERIS's Customers and suppliers to adequately access the credit markets when needed, and (q) STERIS's ability to complete the acquisition of Key Surgical, including the fulfillment of closing conditions and obtaining financing, on terms satisfactory to STERIS or at all. Availability of Securities and Exchange Commission Filings We make available free of charge on or through our website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to these reports as soon as reasonably practicable after we file such material with, or furnish such material to, theSecurities Exchange Commission ("SEC .") You may access these documents on the Investor Relations page of our website at http://www.steris-ir.com. The information on our website and theSEC's website is not incorporated by reference into this report.
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